New CEO at Waddell & Reed will face raft of challenges

Waddell & Reed Financial Inc.'s incoming CEO will face big challenges when he takes the top spot, namely reversing a slide in assets under management, net profits and operating margins.

The Overland, Kan.-based money manager, which specializes in equity and fixed-income strategies, announced May 23 that Philip J. Sanders will succeed longtime CEO Henry J. Herrmann, who plans to retire Aug. 1.

Mr. Sanders, now senior vice president, will retain his title as chief investment officer.

Waddell & Reed spokesman Roger Hoadley said it would be too soon for Mr. Sanders to comment.

“Like all investment organizations, we are continually assessing the resources available to support our investment management capabilities and products,” Mr. Hoadley wrote in an e-mail. “We expect that Mr. Sanders will be taking a fresh look at whether there are additional efficiencies that can be achieved, or resources to be redeployed more efficiently within the organization.”

Mr. Sanders will inherit a company whose assets under management declined to $95.2 billion as of March 31, down 8.8% from three months earlier and down 22.5% from a year earlier, company financial statements show.

Poor investment performance in the firm's biggest funds, particularly the Ivy Asset Strategy Fund, combined with turnover of key portfolio managers and a general trend away from active management, has hurt Waddell & Reed, said Todd Rosenbluth, New York-based director of ETF and mutual fund research at S&P Global Market Intelligence.

Investors flocked into the Ivy Asset Strategy Fund after the financial crisis, attracted to its diversified investment philosophy across asset classes as they looked for a hedge against falling equity markets, Mr. Rosenbluth said.

Investment performance in the fund, the firm's largest mutual fund, was strong initially, but turned negative in 2014, he said.

“It has done what an alternatives fund should not do, lose money,” Mr. Rosenbluth said.

Outflows seem to be worsening. The Ivy Asset Strategy Fund had $5.3 billion in net outflows in the first four months of 2016, Morningstar Inc. data show, compared with $10 billion in net outflows for all of 2015.

The fund had $9.3 billion under management as of April 30, the Morningstar data show, down 73% from $34.6 billion at the end of 2013.

Waddell & Reed's overall institutional assets stood at $14.4 billion as of March 31, but that was before two institutional asset owners withdrew almost $3 billion in April. Waddell & Reed executives disclosed those withdrawals in a conference call with analysts on April 26.

One of the withdrawals was a $2 billion separate account by the Jackson National Life Insurance Co. that was managed by the team that oversees the Ivy Asset Strategy Fund, Mr. Hoadley said in an e-mail on May 24. The other redemption of $800 million was from an undisclosed subadvisory relationship, said Thomas W. Butch, Waddell & Reed's executive vice president and chief marketing officer, during the April conference call.

Those outflows are on top of the $601 million in net institutional outflows in the first quarter of 2016 and $2.3 billion in net institutional outflows for all of 2015.

The company reported net income of $37.5 million in the first quarter, down 40.4% from the previous quarter and down 44.1% from the year-earlier quarter, as fee revenue from clients declined.

Meanwhile, its operating margin of 22.1% for the quarter ended March 31 declined 3.2 percentage points from the previous quarter, and 5 percentage points from the quarter ended March 31, 2015.

The firm's overall operating margin is lower than that of public peers, which currently are in the mid-30s, said Craig Siegenthaler, managing director and equity research analyst at Credit Suisse Group, New York.

Waddell & Reed's adjusted stock price closed at $20.17 on June 9, down more than 70% since it closed at an adjusted high of $69.11 on April 2, 2014.

In a May 3 report, Mr. Siegenthaler said Waddell & Reed eventually could be a target for a merger or acquisition at the right price. He said while domestic interest for midsize traditional asset managers is low, Waddell & Reed's size is perfect for many international investors looking to gain access to the U.S.

Mr. Hoadley said the company is not actively seeking a buyer.

Glenn Schorr, a senior managing director and senior research analyst with New York-based investment research and investment banking advisory firm Evercore ISI, said in an interview that, like many other money managers, Waddell & Reed is too heavily concentrated in offering active stock and bond strategies — for which there have been industrywide net outflows — and less focused on alternatives strategies that are more in demand.

“They are too big in the stuff that's in secular decline and too small in the stuff that's secularly growing,” Mr. Schorr said.

Still, Mr. Schorr said the problems seem greater at Waddell & Reed because its money manager competitors are “much broader, much more diversified,” offering private equity, real estate, exchange-traded funds and smart beta strategies, among others.

Waddell & Reed “had a tougher time on both performance and flows than the overall industry. I don't sugarcoat that,” Mr. Schorr said.

In mid-April, Waddell & Reed filed a registration statement with the Securities and Exchange Commission for approval to offer three exchange-traded managed funds under a licensing agreement from Eaton Vance Management's NextShares funds.

Waddell & Reed also began selling mutual funds in Europe in 2014, but the eight funds have not gained major traction. Combined, they have $167 million in AUM, Mr. Hoadley said.

The Ivy Asset Strategy Fund invests across sectors, but its largest weighting as of April 30 was 47% to equities, said Chicago-based Morningstar analyst Leo Acheson. The fund also has a heavy cash position, almost 22% of the portfolio, Mr. Acheson said.

The fund returned -5.39% between Jan. 1 and May 23 of this year.

The fund does not use a singular benchmark for comparison, but its equity benchmark, the S&P 500, returned 1.1% during the same time period.

For the year ended May 23, the fund returned -17.42% compared with the benchmark's -1.54%. For the three years ended May 23, the fund returned an annualized -2.24% compared with the benchmark's 9.74%, and for five years, the fund returned an annualized 1.06% compared with the benchmark's 11.61%.

Mr. Butch also disclosed in the April 26 conference call that a broker-dealer he wouldn't identify had dropped the fund from its line. The broker-dealer's assets in the fund had dropped to $865 million as of the conference call, from $2 billion in the first quarter, he said.

Mr. Acheson said part of the problem is that key portfolio managers have been leaving. He said the Ivy Asset Strategy Fund's performance began to deteriorate in June 2014 when co-portfolio manager Ryan Caldwell left to co-found asset manager Chiron Investment Management LLC in New York.

A second knock came Feb. 2 when Ivy Asset Strategy Fund's remaining long-term portfolio co-manager Michael L. Avery, also president of Waddell & Reed, announced he would retire at the end of June, Mr. Acheson said.

He said the fund's management has been taken over by Cynthia P. Prince-Fox and Chace Brundige.

Mr. Hoadley, the Waddell & Reed spokesman, said the two co-portfolio managers joined the fund in August 2014 but have long investment industry experience. He said Ms. Prince-Fox has worked 33 years at the firm and Mr. Brundige has 22 years of industry experience and 15 years at the firm. n