The First Quarter 2017 Asset Management newsletter has been released. This quarter’s newsletter focuses on the mutual fund sector, which has been plagued by asset outflows into ETFs and other passive strategies for most of the last decade. The first two months of this year do, however, offer a ray of hope as 45% of U.S. based active managers beat their relevant benchmark, resulting in February being the first month of inflows into active products since April 2015.
We have written at length about bearish signs in the RIA space, and valuation metrics seem to generally reflect a reduced growth outlook. We wonder, though, if things are really that bad. While, we suspect there is, over all, some phantom fee compression in the industry as assets are allocated to passive instruments and active managers who charge more don’t get the RFP they once would have, the other two themes focus on demographics and market outlook which are not, necessarily, bearish for the investment management space.
Brexit’s full impact on the market is still to be determined, but a quick review of asset manager pricing reveals a valuation gap with the broader equity market that opened over the past twelve months, got much worse in June, and even accelerated over the past week. Sifting through the noise at quarter end, we pose, if market valuations in the industry are getting a haircut, what does that mean?
So far this month, the sports world has seen two incredible streaks finally come to an end – Golden State suffered its first regular season home defeat in 54 games, and Real Madrid snapped FC Barcelona’s 39 game unbeaten run in last weekend’s Clasico match-up. Both teams are still poised to retain their respective NBA and La Liga titles this year and break numerous records in the process, assuming their top producers continue their recent form. One streak that remains, albeit less reportedly, is passive funds’ dominance over their active counterparts over the last year.
Tri-State Capital Holdings, Inc. (traded on the Nasdaq as TSC) bought The Killen Group, a $2.5 billion manager of the Berwyn mutual funds, for about six times EBITDA. More specifically, TSC paid Killen $15 million cash up front (based on trailing EBITDA of $3.0 million), plus an earn-out paying 7x incremental EBITDA (which could add another $20 million to the transaction price). So, best case scenario for Killen is for them to deliver about $6 million in EBITDA and get paid $35 million (!).
Despite 195 nations signing onto the Paris Climate Conference commitment to clean energy last week, it looks like Santa will be stuffing most asset managers’ stockings with coal this Christmas. Hopefully it’s at least low-sulfur.
December has been a rough slog for the RIA space. So far it’s mostly been attributed to the cracks in high yield credit. With junk bonds stumbling shortly after Thanksgiving, managers with large high yield offerings are feeling the Grinch. One standout example: WDR. Waddell & Reed’s Ivy High Income Fund has suffered huge outflows this year. Pile outflows with asset devaluation and WDR’s stock has gotten crushed, losing almost a quarter of the company’s equity market cap so far this month (!).
So, as always, the outlook for mutual fund providers hinges on market performance and asset flows. Any continuation of the recent market momentum would certainly be a bonus for mutual fund providers whose net-of-fee performances are competitive with comparable ETF products. Another market downturn, on the other hand, would likely hasten asset flows out of equities and into fixed income or money market funds with lower fees to their sponsors.
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