Five Favorite Investment Management Plays

03/18/2019 5:00 am EST

Focus: FINANCIALS

George Putnam

Editor, The Turnaround Letter

Investment management companies, which manage mutual funds and other investments on behalf of individuals, pensions and other clients, have fallen sharply out of favor, observes leading turnaround, bankruptcy and restructuring expert George Putnam, editor of The Turnaround Letter.

Historically, their shares would loosely track the broad stock market. But since 2014, they have diverged sharply. In just the past year, shares of many of these companies are down by 20%-50%.

What’s going on? First, and most important, the relentless shift toward index-based ETFs has drawn assets away from traditional managers. ETFs now account for $5 trillion in assets, much of which otherwise would be held by the traditional managers. Weak fund performance at many firms hasn’t helped, either. Competition from ETFs has led to lower management fees, further pressuring managers’ revenues.

The steep market decline late last year not only reduced assets under management, but exacerbated investor worries about a recession and a subsequent stock market decline, especially after 10 years of prosperity. That caused more investors to step away from the investment managers’ stocks.

As contrarians, we think there is still good value in these companies. Many of their balance sheets are cash-laden, and cost-cutting has tempered the effects of weaker revenues. Some of the smaller firms might make enticing acquisition targets. Listed below are eight managers whose weak shares offer attractive valuations and dividend yields.

Affiliated Managers Group (AMG)

Affiliated Managers's affiliate model allows it to take majority ownership of some of the industry’s top investment firms. The company’s capable leadership team oversees a diversified stable of managers of public and private equities, fixed income (bond) and alternative investments, while also providing global marketing support.

Its revenue-sharing structure adds a stabilizer to AMG profits in weaker markets while keeping its managers motivated to produce strong returns. Its sturdy balance sheet and healthy cash flows offer opportunities for growth by further acquisitions.

Franklin Resources (BEN)

With $650 billion in assets under management, including the venerable Templeton funds family, Franklin Resources is one of the largest publicly traded investment managers. The firm is well known for its deep research into local markets, illustrated by its 42 research offices around the world.

While recent underperformance by many of its funds has hurt asset retention, Franklin Resources is buttressed by its large $5.9 billion (about $11/share) cash balance. The 40% stake held by the Johnson family likely precludes its sale, but shareholders are occasionally rewarded with sizable special dividends like the $3/share payout last February. 

Legg Mason (LM)

Legg Mason operates as a group of nine independent, specialized investment managers across a range of fixed income, public and private equity and real estate strategies. Founded in 1899, the firm has $755 billion in assets under management with a sizable international component.

The substantial fixed income business, at about 40% of revenues, provides stability against its more volatile equity products, while its expanding ETF offerings should help generate some growth. Part of Legg Mason’s lackluster share price is offset by the $500 million a year it has returned to shareholders, including its recently increased dividend. 

Waddell & Reed (WDR)

Since its founding in 1937, Waddell & Reed has focused on selling its mutual funds through its network of company affiliated advisors. That business model has been losing traction, causing the company’s asset base and EBITDA to shrink 36% and 49% respectively, over the past four years.

However, recently improved investment returns along with stable revenues and lower costs have produced better operating profits. The company has nearly $9/share in net cash on the balance sheet. Trading at only 2.4x EBITDA and paying a 5.7% dividend, WDR shares could be an acquisition candidate or see a rebound if its profits continue to stabilize. 

Westwood Holdings Group (WHG)

Founded in 1983 by secretary turned investment manager Susan Byrne, Westwood Holdings oversees $21 billion in assets. The company’s steady record of asset growth was interrupted last year, but remains poised to stabilize and potentially recover as its funds’ performance has rebounded lately. Cost-cutting has softened the weaker revenue trends.

The debt free balance sheet holds nearly $14/share in cash. Its generous 7.7% dividend yield is not quite covered by earnings, but the dividend recently was increased, indicating some confidence by the company that it won’t need to be cut anytime soon. 

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