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Money Management

Active managers feel pain as asset drain continues

Quarterly reports show no abatement in trend to passive management

Craig Siegenthaler
Credit Suisse’s Craig Siegenthaler

The fourth quarter continued a positive storyline for BlackRock (BLK) Inc. (BLK), with $98 billion in net inflows, while many other money managers saw net outflows or tiny net inflows.

Those developments capped a year in which net outflows for active strategies hit a record high and shares in asset managers fell before a post-election rebound. Flat profits and revenue dogged most publicly traded asset managers, but their operating margins remained high.

For 2016, BlackRock, the world's largest asset manager with $5.1 trillion in assets under management, reported a record $202 billion in net inflows, riding the growing popularity wave of passive strategies and exchange-traded funds, said Craig Siegenthaler, a managing director and equity analyst with Credit Suisse Group, New York.

Passive strategies and ETFs made up $3.2 billion of New York-based BlackRock's total assets under management, show company statistics. Inflows for the fourth quarter ended Dec. 31 included $49.3 billion into BlackRock's iShares ETF unit.

Vanguard Group, the Malvern, Pa., manager with the $3.9 trillion in assets, was another major beneficiary of net inflows, with $322.8 billion for the year. The company, known as a leader in passive investing, reported a net $77.3 billion into U.S. mutual funds and ETFs in the fourth quarter. Vanguard is not publicly traded; it is owned by investors in its funds.

“There are a few guys winning a lot of the business and there's a lot of guys losing a little bit of business,” said Mr. Siegenthaler.

He said as assets move from active strategies, it sets up a positive scenario for the small number of managers specializing in passive investing: BlackRock and Vanguard as well as State Street Global Advisors, Boston. Mr. Siegenthaler said that leaves a majority of asset managers — those that specialize in active strategies — on the losing end.

Still, State Street Corp. (STT), the parent of SSGA, reported net outflows of $42 billion in 2016, which company officials attribute to redemptions in money market funds and passive equity strategies. SSGA's ETF business, however, had positive inflows in the quarter and the year.

SSGA saw $16 billion in net inflows for the fourth quarter, but that was tempered by net outflows of $36 billion in the third quarter and $35 billion in the second quarter. In the first quarter, it reported $13 billion in net inflows.

Bad year for active

Mr. Siegenthaler said 2016 was a bad year for active managers.

Active manager Franklin Resources Inc., San Mateo, Calif., for example, saw net outflows of $14.4 billion for the Dec. 31 quarter and $67.9 billion for the calendar year. BNY Mellon Investment Management reported $14 billion in net outflows for the quarter and $23 billion for the year. Legg Mason (LM) Inc. (LM) saw $10.9 billion in net outflows for the quarter and $26.2 billion for the year. T. Rowe Price Group Inc. had $5 billion in net outflows for the quarter and $2.8 billion for the year. And Affiliated Managers Group Inc. reported $4.1 billion in net outflows for the quarter but $7.4 billion in net inflows in the year.

The analyst said active strategy mutual fund outflows set a record of $305 billion in 2016, and the last three months were probably “the “worst quarter in history.” Net outflows from active mutual funds in 2016 were up 31.4% from 2015, Credit Suisse data show.

Mr. Siegenthaler said better performance in passive strategies along with the implementation of the Department of Labor fiduciary rule, slated for April, were driving flows into lower-cost passive options.

Active manager T.Rowe Price, Baltimore, was forthright in its latest earnings release, saying the firm's net outflows for the fourth quarter and calendar year “are largely attributable to institutional and intermediary clients reallocating to passive investments.”

A Jan. 30 report from Goldman Sachs equity research said “clouds” were forming over T. Rowe Price's $189 billion target-date fund franchise with T. Rowe's disclosure that the company in the fourth quarter saw $63 million in net outflows, its first ever in that area. The report said that since 2012, target-date funds — which make up 23% of T. Rowe Price's AUM — have been “the only source” of organic growth for the firm. With flows having turned negative, the company is “increasingly more exposed to growth challenges posed by passive products given the firm's reliance on target-date funds,” the report said.

Among publicly traded asset managers generally, overall profitability still remained high but flat revenues and earnings were a common theme for the quarter and the year, said Robert Lee, a managing director and equity analyst at Keefe, Bruyette & Woods in New York.

Mr. Lee said fees continue to face pressure. “It's not like asset managers are cutting fees right and left,” he said. But Mr. Lee said investors moving to lower-fee strategies affected fee revenue among some asset managers.

Even BlackRock (BLK) was not immune from the fee pressure. Net earnings of $851 million in the fourth quarter were down 3% from the previous three months and 1% for the year from 2015 because the manager collected less in investment management fees.

Many asset management stocks approached five-year lows in 2016 before leaving the basement, like other financial stocks, in a rally after Donald Trump's presidential election victory. But many are still trading at a substantial discount to highs in 2015, Bloomberg data show.

Cutting costs

To maintain margins, asset managers have been cutting costs wherever they can, said New York-based Glenn Schorr, a senior managing director and a senior research analyst at Evercore Group LLC. “Most managers' margins are down some,” he said. “They are trying to negate the loss of assets by cutting expenses. If they didn't do this, margins would get killed.”

Some managers reported higher operating margins in the latest quarter despite smaller AUM and negative flows. The 37.6% operating margin of Franklin Resources was up from 35.9% in the previous quarter, despite the fact that assets were down 2% to $720 billion in the same period.

“Effective expense management resulted in increased operating income,” the company explained in its latest earning release.

Not all managers are cutting expenses. T. Rowe Price is expanding its distribution staff, which is adding to costs, said Chicago-based Christopher Shutler, an equity analyst with William Blair & Co. He said the firm increased operating expenses by 5.3% in 2016 and expects expense growth to rise by 8% in 2017.

Mr. Shutler said T. Rowe Price wants to build its presence in overseas markets, though such efforts may take time. “It's somewhat amazing that T. Rowe Price is a tremendous brand in the U.S. but only 5% of their assets come from non-U.S. investors,” he said.

Janus merger schedule

Denver-based money manager Janus Capital Group used its fourth-quarter earnings statement to lay out its merger schedule with London-based Henderson Group. It says the merger is scheduled to be completed on May 30.

Janus reported $300 million in net outflows in the quarter ended Dec. 31, down from total net outflows of $2.4 billion in the previous three months. Janus would have had positive net inflows were it not for the firm's institutional quantitative investment division, INTECH, which saw $1.6 billion in net outflows for the quarter on top of $1.8 billion in net outflows the previous quarter.

INTECH's net outflows are of concern not only to investment analysts but to Janus CEO Richard Weil. In a Jan. 24 conference call with analysts, Mr. Weil disclosed that none of the $46.1 billion quant division's seven investment strategies outperformed their benchmarks for the year.

INTECH equity strategies in aggregate returned 0.1% in the fourth quarter and 0.9% in the previous quarter, show Janus data.

Mr. Siegenthaler said INTECH performance issues are a key reason he expects overall net flows from Janus to continue on a negative path.

Mr. Weil said in the call with analysts that Janus did a review of the INTECH's proprietary quantitative model, describing it as “still a very good process.”

He wants investors to reach the same conclusion. “Hopefully, they will, like I have, conclude that this (poor performance) is not a reason to lose confidence, but clearly, this is a huge challenge for INTECH to carry in the year and years ahead.”

This article originally appeared in the February 6, 2017 print issue as, "Active managers feel pain as asset drain continues".