Asset growth loses luster with market

Asset increases are no longer enough to raise the share prices of publicly traded financial services firms with traditional money management units.

That was borne out by those firms' share prices that fell from Oct. 12-31 — the period when most reported third-quarter assets under management that averaged a 1.48% increase from the end of the second quarter. In fact, during the nine-day trading period from Oct. 12-24, share prices of some of the largest financial services firms took a significant hit, only to rebound somewhat by month's end.

"What is true about the market hit (on share prices) is that historically, the industry just focused on asset growth," said Amanda Walters, senior manager at consulting firm Casey Quirk, a practice of Deloitte Consulting LLP, New York.

"We're seeing a lot of CEOs now focusing on profitability rather than just asset growth" in their earnings conference calls with analysts. "They'll always focus on assets under management and investment performance, but that's the legacy part of the industry. Now it's a focus on revenues, fees and profits," she said.

State Street Corp. (STT), Boston, took the biggest hit to its stock value from Oct. 12 through the end of the month, down 15.9% to $68.75 — this despite its State Street Global Advisors money management unit reporting third-quarter AUM increasing 3.2% to $2.81 trillion.

But other large managers saw share value declines as well:

BlackRock (BLK) Inc. (BLK), down 1.5% to $411.42 — rebounding from a 9.3% drop from Oct. 12-24 — despite a 2.3% AUM jump to $6.44 trillion.

Voya Investment Management, down 7.4% to $43.76, compared to an 11.4% decline Oct. 12-24, while assets increased 2.3% to $298.1 billion.

Bank of New York Mellon (BK) Corp, (BK) down 3.8% to $47.33 — also bouncing back from a 7.8% drop Oct. 12-24 — while assets rose 1.3% to $1.83 trillion.

Overall from Oct. 12-31, the S&P 1500 Asset Management and Custody Bank index fell 4%, while the Dow Jones U.S. Asset Managers index was down 3.97%. The S&P 500 total stock index, despite losing 6.84% for the full month only slipped 0.56% from Oct. 12-31, while the Dow Jones U.S. Total Stock Market index, which fell 7.5% for the month edged down 0.77% from Oct. 12-31.

Not an anomaly

The performance divergence between money manager stocks and the broader equity market isn't an anomaly. Year-to-date through Oct. 31, the S&P asset management index was down 21% vs. a 3% increase in the S&P 500, while the Dow Jones managers index was down 20.8% compared to the Dow Jones TSM's 0.9% increase. Most publicly traded traditional managers reported low- to mid-single-digit percentage revenue increases for the year ended Sept. 30.

What's been happening, sources said, is that the long-term increase in investment returns sustained asset gains for those firms' money management businesses during an extended bull market that began after the financial crisis. But as the market has ebbed, AUM gains are being overshadowed by long-term issues in the broader financial services industry — everything from net asset outflows from traditional managers to more alternative investment firms, to reduced gains in overall revenue and net income beyond money management. And those issues have become front and center with investors.

"It's been a (more) volatile market broadly for the asset management industry than previously," said Casey Quirk's Ms. Walters. "You see that impacting the overall growth story. The factors at play from a fee and a growth perspective have been exacerbated. Future price-to-earnings ratios look at just margin. Publicly traded firms manage to their margins."

While BlackRock (BLK)'s net income rose 14% to $1.22 billion in the third quarter, the news was tempered by the firm's report that revenue was down 0.8% to $3.58 billion and it had $24.8 billion in institutional net outflows for the quarter. Daniel Fannon, analyst at Jefferies Group LLC, San Francisco, said in a note to clients reaffirming its "hold" rating on BlackRock that the institutional net outflow was "the biggest delta" coming out of the company's earnings report. Operating margin at BlackRock for the third quarter was $43.58, up 1% from the second quarter but down 9% from a year earlier.

Voya's stock decline occurred prior to its third-quarter earnings announcement on Oct. 31, when it reported revenues of $2.25 billion, up 6.6% for the quarter but down 11.7% from the third quarter 2017; net income for the latest quarter was down 14.5% as a result of the June 1 divestment of its variable annuity business. Operating margin was $4.08, down 23.8% from the previous quarter but up 154% from the year-ago quarter. After its third-quarter announcement, Voya stock rose 10.3% to close at $45.63 on Nov. 9.

AUM gains not enough

For larger financial services firms, AUM gains in money management weren't enough to offset losses in other businesses. In the case of State Street, an increase in third-quarter management fee revenue by SSGA, up 1.9% to $474 million, was not reflected in parent State Street Corp. (STT)'s overall revenues, which were down 2.5% to $2.95 billion. Analysis from Keefe, Bruyette & Woods Inc. said State Street's operating results "were much worse than KBW analysts estimate as revenues missed widely" and analysts warned State Street shares would underperform following its earnings announcement. However, parent company operating margin was 28.88% of its revenues in the latest quarter, up 2.8% from the second quarter and 1.7% higher than the year-earlier quarter.

At BNY Mellon, investment management revenues of $909 million, which were up 1.3% from the previous quarter, did not help overall company revenues that were down 1.7% to $4.07 billion and net income at $1.08 billion, unchanged from the second quarter. Third-quarter operating margin was 34.06% of its revenues, down 2.7% from the previous quarter and down 3.8% from the previous year.

Ms. Walters said the decline in the firms' stock values last month was also influenced by the overall market decline as well as the uncertain news on their net income and revenue.

"It was a little of both," she said. "We've had a 10-year bull market. At some point, that will change. It's too soon to see if that began in October."

'Not a simple question'

Michael Falk, partner at money manager consulting firm Focus Consulting Group LLC, Long Grove, Ill., said determining whether future share prices for companies with money management units will continue to decline "is not a simple question" and relates as much to the overall move to passive investment from active management as it does to any manager business fundamentals.

"We know how investors can overreact," said Mr. Falk. "When you think long term about active money management, if you look at the recent past, flows largely have been negative vs. indexed assets. If you extrapolate those flows to a longer time period, these active businesses are going to shrink. The big shift from active to indexed seemed to come on the heels of the Great Recession. The industry broke trust. While it's in everyone's best interest to save long term, do you want to place a bet with an active manager charging 50 to 100 basis points or more when you can often do much the same for under 10 basis points or free?"

Jefferies' Mr. Fannon in a separate note to clients warned that "fee pressure and active equity outflows continuing to be a secular trend for the industry and modest increases in investment spend (or at a minimum flat), we would expect operating compression for most in the group."

Along with general AUM increases in the third quarter, nine of the 19 publicly traded traditional managers monitored by Pensions & Investments reported net inflows in the third quarter, compared to the previous quarter when only five managers reported net inflows. Not all firms report net flows.