Back in the High Life

12/29/2009 9:02 am EST

Focus: GLOBAL

Peter Shearlock

Editor, Growth Company Investor

Venerable UK investment manager Schroders has been rejuvenated by the improved performance of its funds, writes Peter Shearlock in The IRS Report.

No industry is more closely tied to the health of the stock market than investment management. With management fees largely based on the value of funds under management, rising markets automatically boost profits. Falling markets have the reverse effect, and because investment managers’ costs are often inflexible, can wipe out profits entirely. Swings in investor sentiment reinforce this linkage.

At Schroders (LSE: SDR), one of the industry’s oldest names, they have had to deal not only with the effects of market swings, but until recently, a long-term decline in institutional business. Quite simply, Schroders got caught out by a change in fashion. Some time around the early 1990’s, pension fund administrators started to turn their backs on traditional “balanced” investment management, which had been Schroders’ forte.

Suddenly, the people in charge of Britain’s pension funds wanted something different. Many plumped for a core/satellite approach in which the biggest chunk of cash was invested in low-cost index funds and the remainder parceled among a slew of specialist managers. Schroders offered none of this and paid the price. It did not help that investment performance was distinctly average. A stream of pension fund money flowed out the door.

But the business has been much restructured in the past three or four years. Management has broadened the product range to include areas such as emerging market debt, commodities, and funds of hedge funds, and opened up new distribution channels. Most importantly, perhaps, it has transformed the investment performance. At the end of September, 85% of the funds were showing outperformance over one year. The numbers were almost as good over three years.

This was of little help in 2008, when funds under management shrank by a fifth to £110 billion. About half the fall was down to the collapse in share prices. This year, the story has been dramatically different: A net inflow of £7 billion [in the third quarter] helped funds under management rise a remarkable 23% to £139 billion.

Not surprisingly, Schroders shares have performed strongly since the turnaround first became apparent in the summer. But they have had a bit of a pullback since Dubai’s decision to suspend payments on its massive debts—a move that has sent tremors through all world markets. That has left them looking [of] better value.

Importantly, thanks to the strong investment performance of its funds over the last few years, Schroders is once again in the [good graces] of the consultants who advise pension funds and the like on their choice of investment managers. Coupled with the support of a cash-heavy balance sheet, that suggests the firm is in better shape than at any time in the last couple of decades. It looks an attractive medium-term play on a continuing market recovery. (The shares closed at 1,316p in London on Monday—Editor.)

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