Outflows vex asset managers facing a cloudy economic forecast

Most publicly traded money management firms saw net outflows in the June 30 quarter, as concerns mount on a more clouded future and investors continue their shift from active equity strategies.

Data from Goldman Sachs Group Inc. show net outflows for publicly traded managers were around 2.9% in the June 30 quarter, higher than the 2.3% of the previous quarter.

The net outflows come as active equity strategies, the bread and butter of many traditional managers, remain under severe pressure. The asset management industry saw $131 billion flow out of active mutual funds in the first six months of 2016, the largest amount since Morningstar Inc. began recording the data in 1994.

Data from eVestment, which tracks institutional separate accounts, show net outflows from active equity strategies peaked at $123 billion in the fourth quarter of 2015. In the first quarter of 2016, net redemptions were a smaller but still significant $74.2 billion. eVestment has not compiled second-quarter 2016 data.

In the second quarter, even small active equity inflows were something for asset management executives to highlight. Janus Capital Group CEO Richard Weil said during the company's July 26 earnings call with analysts that the company's fundamental equity strategies had net inflows of $300 million, even though active equity industry flows are on pace this year to be the worst in 25 years. He noted the positive $300 million compared to $300 million in net outflows in the first quarter.

“Our fundamental equity business is growing at a time when the rest of the market is dramatically shrinking, and that for me is the real headline,” said Mr. Weil.

But the news wasn't entirely positive for Janus; its quantitative equities unit, INTECH, saw $700 million in net outflows in the quarter.

Janus reported total assets under management of $194.7 billion at the end of the June 30 quarter; INTECH's AUM as of June 30 was $49.1 billion.

Compounding the problem for money managers has been their active equity strategy performance. Only 23% of 6,858 active equity mutual funds beat their benchmarks in the first seven months of 2016, show Morningstar data.

One firm particularly hard hit in the quarter was Overland Park, Kan.-based Waddell & Reed Financial Inc., which has experienced performance problems in its largest active equity strategies. “We've certainly stubbed our toe and are accountable for our own performance,” said CEO and Chief Investment Officer Philip J. Sanders in a July 26 conference call with analysts. “But I would say the backdrop has been unusual for the active management world. It's been one of the toughest first halves in history with respect to the performance of active managers.

“The current global macroeconomic and geopolitical backdrop has resulted in heightened investor demand for stability, safety and yield, resulting in valuation anomalies across various sectors and markets,” Mr. Sanders said, but added those anomalies will be removed over time, creating a more favorable climate for active management.

“The recent performance challenges for active managers combined with an increased focus on fees has resulted in growing demand for passive products,” he said. “We understand that the landscape has changed, but believe that there is a role for both passive and active strategies in client portfolios.”

Waddell & Reed reported net outflows of $9.8 billion in the June 30 quarter, including $5.5 billion from institutional strategies. The company had $8.9 billion in institutional assets under management as of June 30, down 37.8% from the previous quarter. Total assets under management were $86.4 billion, down 9.2% from the previous three months.

Other managers with net outflows in the June 30 quarter included State Street Corp., $35 billion; Franklin Resources Inc., $19.2 billion; T. Rowe Price Group Inc., $2.7 billion; Artisan Partners Asset Management Inc., $2.3 billion; and Legg Mason Inc., $1.1 billion.

Legg Mason statistics showed outflows from active equity strategies were the most severe of any asset class at the firm, amounting to $3 billion in the June 30 quarter. Fixed-income inflows of $3.9 billion, helped reduce total outflows, the company said.

Not all managers with net outflows were equity-oriented shops. Pacific Investment Management Co., the fixed-income giant, saw net outflows of e18 billion ($19.9 billion) in the June 30 quarter, which was blamed on a reallocation of assets from some large institutional clients.

Officials of PIMCO's parent, Munich-based Allianz SE, said Aug. 5 that the number increased from the previous three months when PIMCO saw $11 billion in net outflows.

The Newport Beach, Calif, manager, with $1.5 trillion in assets under management,  has seen hundreds of billions of dollars in withdrawals since the departure of co-founder and CIO William Gross in September 2014.

Allianz also noted in a report posted on its website that the first half of the year was a difficult time for the asset management industry because of market volatility, increased flows into passive strategies and rising distribution costs.

BlackRock Inc., the world's largest asset manager, reported second quarter net inflows of $1.54 billion, which excludes money market and advisory business assets. However, active equity net outflows amounted to $6.7 billion in the quarter.

BlackRock's net inflows for the June 30 quarter were also just a sliver of the $36.1 billion it garnered in the first quarter of 2016.

But some managers fared better with outflows when compared to the three previous quarters. Legg Mason's $1.1 billion in net outflows in the second quarter was down from $13.2 billion in the first quarter. Franklin Resources saw $24.4 billion in net outflows in the first quarter.

And while outflows have caused margin compression at money management firms, the public perception of the business is actually worse than the reality, said Glenn Schorr, senior managing director and senior research analyst at Evercore Group LLC, New York.

“Some of the companies are still earning 40%-plus pre-tax margins and some of these companies are in the 30% range,” he said. “It's hardly a dying business, yet if you ask the average person, they'll tell you it's a dying business.”

A review of company earning statements shows that publicly traded money management firms have had small reductions in their operating margins over the past 12 months.

BlackRock, with $4.89 trillion in assets under management, reported a 41.8% operating margin in the June 30 quarter vs. 42.6% in the year-earlier quarter. Franklin Resources reported 36.4% operating margin in the June 30 quarter compared to 38.5% a year earlier. And Janus reported a 27% operating margin in the June 30 quarter, down from 30.2% in the year-earlier quarter.

Some managers have been hurt more than others. Waddell & Reed reported a 16.8% operating margin in the second quarter, down from 28.2% for the same quarter of 2015.

The pain could intensify for managers that rely primarily on active equity and have not diversified, said Neal Epstein, New York-based vice president and senior credit officer at Moody's Investors Service. “I think we do agree that a very generic player is going to have the rug pulled out from under their feet.”

While operating margin compression hasn't been large for many asset managers, it still worries those investing in manager stocks who are concerned about a lack of earnings growth, said Erik Oja, an equity analyst with S&P Global Market Intelligence, New York.

Mr. Oja said the S&P 1500 Asset Management & Custody Banks index showed the average price of asset management company stocks declined 28.3% between May 20, 2015, when the index reached a high point, and Feb. 11. The stocks have recovered slightly since then, with the index showing a 14.7% decline as of Aug. 3 from the high mark as concerns about a recession and an economic slowdown in China have subsided, Mr. Oja said.

As the shift from active equity strategies accelerates, investors will be looking not just at passive equity strategies but alternatives too, believes Craig Siegenthaler, managing director and equity research analyst at Credit Suisse Group AG, New York.

Mr. Siegenthaler said BlackRock and Invesco Ltd. are two managers well positioned to continue growing their assets because both significantly diversified their investment offerings to include a variety of alternative strategies.

“Institutional investors are increasingly desperate to meet their liability hurdle rates in today's low-rate environment and they are going to be allocating more money to illiquid alternative strategies like real estate, private equity and credit,” he said.

BlackRock, with its dominant share of the ETF business through its iShares division, is also in a very good position to capture the increased business going to passive strategies.

Mr. Siegenthaler said other beneficiaries of the increasing shift to illiquid alternatives will be firms like Blackstone Alternative Asset Management LP, Carlyle Group, Apollo Global Management LLC and KKR & Co., which will be able to build their asset base at the expense of traditional asset managers.

Of the four firms, Mr. Siegenthaler sees Blackstone as being in the best position to benefit because it had expertise in three diverse areas beyond private equity: real estate, credit strategies and hedge funds.

Most traditional asset managers have begun to realize that they need to offer a broader range of investment strategies beyond active equities, but introducing alternatives is not a quick-fix solution because institutional investors want a three- to five-year track record said Robert Lee, an analyst and managing director with Keefe Bruyette & Woods Inc. in New York. “It takes time to build a sufficient track record,” he said. n