Asset managers may be too weak to lead recovery

Publicly traded asset management companies tend to lead market recoveries, but the fast and brutal decline in mutual fund assets makes the firms' ability to front a recovery doubtful. "They will lag the market," said Michael Kim, an analyst with Sandler O'Neill & Partners LP of New York. "The earnings power of these franchises has been significantly compromised, given the level of asset decline." Total assets in mutual funds at the end of 2008 were $9.6 trillion, down from $11.99 trillion at the end of the previous year. A "tremendous" amount of wealth has been lost, particularly for retail investors, which potentially affects traditional asset allocation strategies, Mr. Kim said. Retail investors now may be much more leery of actively managed funds, preferring instead to stick with low-cost index, fixed-income or money market products, he said. "Their tolerance for risk could be permanently impaired." That's not good news for any asset manager. But such a change in tolerance particularly affects less-diversified, equity-oriented firms.
It's why Janus Capital Group Inc. of Denver and Calamos Asset Management Inc. of Naperville, Ill., have been placed "under review" by Morningstar Inc. of Chicago, said Gregory Warren, an analyst with the firm. Janus Capital manages $60.76 billion in mutual fund assets and Calamos Asset Management has $12.9 billion under management, excluding money market funds, as of Jan. 31. Janus is in a precarious position. Its rating dropped a notch to junk status last week, courtesy of Standard & Poor's of New York. And with regards to Calamos, Mr. Warren said, "My thought about putting it under review was that it's just going to be really tough for them." The firm's offerings are "overwhelmingly" tied to the U.S. equity markets, he said. Both companies find themselves in such weakened positions that they could possibly become acquisition targets, Mr. Warren said. There is no doubt that asset managers across the board are hurting, said D.J. Neiman, an analyst with William Blair & Co. LLC of Chicago. He agrees such companies may not lead when the stock market recovers. "Money flows will determine the trajectory of earnings," Mr. Neiman said. "Absent a large inflow of assets, earnings will lag an overall recovery." But long-term, the business model is still attractive, Mr. Neiman said. "There's hardly any capital requirements for this business, but still, on a relative basis, it generates high margins," he said. "Where else are you going to go to find that?" Some asset managers are positioned better than others. Franklin Templeton Investments of San Mateo, Calif., with $215.7 billion in mutual fund assets under management, excluding money market funds, has "close to a fortress balance sheet," said Robert Lee, an analyst with New York-based investment bank Keefe Bruyette & Woods Inc. It has virtually no debt and tons of cash, he said. Invesco Ltd. of Atlanta is another firm that seems well-positioned to come out of the current market unscathed, Mr. Kim said. Invesco has about $32.5 billion in mutual fund assets under management, excluding money market funds. "If you think the markets will remain flat to down, their best-in-class scale and diversification will allow them to sustain assets and earnings better then most peers," Mr. Kim said. Invesco oversees the Aim Funds in Houston and exchange traded fund adviser Invesco PowerShares Capital Management Inc. of Wheaton, Ill. T. Rowe Price Group Inc. of Baltimore, with mutual fund assets under management of $172.5 billion, excluding money market funds, saw its assets decrease by more than 30% last year, but the firm is still better-positioned than others to do well when the markets recover, Mr. Neiman said. It's a well-respected firm that has resisted big head-count reductions, he said.

A 'RED FLAG'

Such cutbacks have become very common among asset managers. Last month, privately held Fidelity Investments of Boston initiated a second round of layoffs. The company said last year that it would lay off about 3,000 employees — 1,300 in November and 1,700 during the first quarter of this year. Fidelity Investments has about $589.4 billion in mutual fund assets under management, excluding money market funds. Layoffs have also been announced at Putnam Investments of Boston; the privately held The Capital Group Cos. Inc. of Los Angeles, whose Capital Research and Management Co. unit advises the widely popular American Funds; and BlackRock Inc. of New York. Mutual fund assets under management, excluding money market funds, for Putnam Investments is $38.74 billion, while BlackRock manages $74.55 billion and Capital Research and Management has $689.9 billion under management. Such cuts may be necessary in the short run, but they could cost the firms investors over the long run. "It's a red flag,' said Jim Holtzman, an adviser with Legend Financial Advisors Inc. of Pittsburgh, which manages about $300 million in assets. "We have to look at [whether] layoffs [could] have an effect on the performance of the funds themselves?" In most cases the answer is no, because fund companies — particularly larger fund companies — try not to cut those directly associated with running their funds. It's more of an issue for smaller companies that may have no other choice but to cut those workers associated with investment management, said Gregory H. Makowski, a principal of CFS Investment Advisory Services LLC, a Totowa, N.J.-based firm with about $500 million under management. "Now is the time to look at the larger fund companies that have staying power," he said. Such concerns are understandable, but things aren't as bad for the asset management industry as some observers make it out to be, said Brian Reid, chief economist for the Investment Company Institute, the Washington-based trade organization for the asset management industry. There have been outflows — the worst, occurring in October and November, totaled 3% of equity fund assets — but given the stock market's decline, the fact that such a small percentage of assets were yanked from funds shows that there isn't a mass exodus, he said. "What we're observing is not out of line for what we have observed historically," Mr. Reid said. E-mail David Hoffman at dhoffman@investmentnews.com.