Just a couple of days ago, we published a review of how asset managers have performed during the past months. Today we are going to talk about how Wells Fargo & Company (NYSE:WFC) looks at this industry, and the performance of the $122 trillion industry. The top 25 asset managers control roughly $30 trillion of the total AUM.
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Wells Fargo & Company (NYSE:WFC) has begun covering six asset managers, Legg Mason, Inc. (NYSE:LM), T. Rowe Price Group, Inc. (NASDAQ:TROW), BlackRock, Inc. (NYSE:BLK), Franklin Resources, Inc. (NYSE:BEN), Invesco Ltd. (NYSE:IVZ), and Manning and Napier (NYSE:MN). It expects BEN and TROW to Outperform during the rest of the year, while the rest are expected to perform neutrally.
WFC rates its best performers in asset managers more on the basis of their ability to deliver positive alpha, rather than how well they perform on a competitive basis. Following this scale, T. Rowe Price Group, Inc. (NASDAQ: TROW) easily comes off at the top. TROW was able to deliver positive returns on all 1,3,5,10 year scales.
The asset managing industry stands on high cash inflows and this translates to low capital expenditures and low capital ratios. Hence, asset managers are able to give 50-100% of income back to shareholders. In these terms, T. Rowe Price Group, Inc. (NASDAQ:TROW) and Franklin Resources, Inc. (NYSE:BEN) have the highest ratio of capital returns where they return a more than $8 share in cash. Handsome capital returns are likely to grow, as asset managers increase dividends and buyback shares. Legg Mason, Inc. (NYSE:LM) is commencing a buyback plan to repurchase shares worth $1 billion.
In terms of operating margins, the best performers have been T. Rowe Price Group, Inc. (NASDAQ:TROW) and Franklin Resources, Inc. (NYSE:BEN). The good performance is attributable to mergers and acquisitions (M&A) and organic growth, the stats will not be as strong when analysis is made on the basis of constant AUM. So the scale of measurement is crucial as to how performance is judged in these areas. The six asset managers group that WFC is following are undervalued on the basis of their P/E ratio and the premium to the S&P 500 index. The group underperformed in 2010 and 2011. The P/E ratio is down on the three year average throughout the group. Volatility and investing at the wrong time has led to spells of underperformance, but in general the cumulative returns were 80 percent, which are above the 20 percent return on the S&P 500 (INDEX.INX) index in the past decade. The group of six is up 6 percent year to date. The group has done well on a long term basis.
The data also makes sense from a logical point of view. Equity markets tend to increase over time. Asset managers gain from both the increase in equities and fund flows, as investors pour money in when times are good.
Bonds Vs. Equities
For the past four years, the bond mutual funds have received massive inflows, with only a single quarter making an exception. On the other hand, US equity went through $456 billion in outflows during the same period. The US equity has been down in most of the quarters since 2008, with only three quarters showing positive flows. While the international equity has done much better in comparison, with 12 positive quarters. Wells Fargo & Company (NYSE:WFC) expects this trend to continue until macro indicators strengthen and a global economic recovery spreads. The results are surprising, when the bond market has suffered through historically low interest rates. There are many analysts and economists, like Dylan Grice and Andy Lapthorne from SocGen, who believe that the likes of high yield bonds are essentially junk. However the bond market continues to grow.
The thesis also sees the U.S. retirement market as a big opportunity. The total assets here have grown three times as strongly as the equities in the US. These assets are expected to grow with a $2 trillion contribution from IRA in the next five years. As the growth continues in retirement assets, this proves as an upside for asset managers. Index mutual funds and exchange traded funds (ETF) are also growing in comparison with the active investments. ETFs are up at 12 percent market share from just 1 percent, while index mutual funds have grown to 11 percent from 8 percent. The top factors in favor of ETFs are their low cost, convenience, and investment flexibility.
There is also huge potential for growth in the global markets. Asset managers only invest 20 percent of their portfolio in markets outside of US and Europe. International AUM has grown to 50 percent in the past decade. WFC expects strong growth in these areas, as Asian markets emerge as new contenders. Revenues in industry fees are also declining for some asset managers, the average fee is down by 4bps since 2007. The increased investment in passive products and inflow to fixed income products has driven the asset managers to make reductions in their fees.
The analysis cites intense competition in the asset management industry, new regulation laws and policies, volatility in equity and bond markets, growth in passive products, and the loss of key employees as important risk factors. Moreover, venturing into international markets can not just drive profits, but can also expose asset managers to foreign laws and risks.