Citi says its a case of 'horses for courses' when investing in asset managers

It has been a rough year for markets this year but, as a group, UK asset managers have had an even tougher time, with their share prices having fallen by about 30 per cent more than the UK market to date. But there are judicious investment cases to be made across the sector, with Citi plumping for Man Group (LON:EMG) and Ashmore (LON:ASHM) in a falling market, and Jupiter (LON:JUP), , in particular, for the rebound.

Based on historical performance, including in the dark days of 2008/09, Citi reckons that, so far, the asset management sector is “behaving as it should”. It does not expect August’s market volatility to lead to as great a revenue shock as the 2008-09 downturn.

In 2008, the FTSE All Share fell 33 per cent and the average UK asset manager returned minus 46 per cent. Strong recovery came through swiftly, however, with the UK market up 25 per cent in 2009, and the average UK manager generating a positive 54 per cent return.

So, if historical parallels continue, the broker expects to see asset management stocks “rebound quickly and assertively”, even if earnings trends continue to decline, as companies adapt quickly to protect operating margins.

The triggers for recovery last time round were signs of improving fund flows and announcement of cost efficiency and cost cutting programmes.

Yet not all asset managers will fall or recover by the same amount. The broker notes that Ashmore, Henderson and Aberdeen, for example, have outperformed the FTSE year to date, reflecting their exposure to more resilient emerging market debt, as characterised by Ashmore; and rising profitability trends - with Henderson benefitting in this respect from acquisitions,  and Aberdeen from its judicious mix of flows.

Others in the sector have fared less well in a falling market, as would be expected. Citi reckons some of the players have moved way too far from where they should be.

The extent of underperformance by Jupiter, for instance, “looks exaggerated” to the broker; while the relative underperformance of Man Group seems “overly harsh” when considered alongside recent positive momentum in the performance MAN’s key AHL managed futures unit.

In assessing the prospects for asset managers in either falling or rising markets, it is always worthwhile having a good look at their client base. Market falls and volatility have a real impact on fund flow trends and this effect is most marked for retail fund flows, which have tended historically to respond more quickly to movements than their institutional counterparts.

The most retail focused fund managers are Jupiter, with almost 80 per cent exposure to this client group, followed by Henderson (45%) and Schroders (37%).

Citi notes that while Man Group appears to have a high “retail” proportion of investors, this really reflects a high proportion of private client and high net worth investors, who cannot really be classed within the general retail population.

Within these retail fund managers, those with the highest equity proportions are most sensitivity to market levels and in Citi’s view, managers with high UK retail exposure are likely to see net withdrawal of fund flows in the second half of 2011.

It adds, though: “ Historically, high volatility combined with market falls has led to swift response in the form of net retail outflows, but these then reverse relatively quickly once markets recover.”

The picture is a little different on the European retail front. Those with high European retail exposure are likely to see “a continued lacklustre fund flow environment” on slow recovery in investor confidence in equities.

Historically as well, the European investor has been less keen to return to fund investment even after the markets have recovered.

More broadly, it has also been historically the case that threat of lower AUM and lower profits tend usually stimulate M&A activity. Throw in rising regulatory cost burdens too, as is the case now, and consolidation to achieve greater economies of scale seems a likely outcome in Citi’s view.

However it believes most of asset managers in its universe are more likely to be consolidators than targets, with the possible exceptions of “pure play” targets, such as Ashmore and Jupiter, although significant blocking stake shareholdings here would make any deals more challenging.

Looking at the investment case, then, Citi reckons that over the short term falling markets will mean lower AUM, lower management fees and lower performance fees.

Longer term, downbeat markets and high volatility could increase investor fear, leading to subdued and/or negative fund flows.  That in turn would delay AUM and revenue recovery, even if markets recover swiftly from here on in. 

To reflect its caution and new lower earnings per share forecasts, the broker has reduced its price targets for asset managers by an average 11%. At the same time it has downgraded Schroders (LON:SDR) from ‘buy’ to ‘hold’ and upgraded Ashmore from ‘hold’ to ‘buy’.

All of its other ratings unchanged. F&C Asset Management (LON:FCAM) remains on ‘hold’; Henderson is a ‘buy’; Jupiter a ‘buy’; Man Group a ‘buy’; and Aberdeen Asset Management (LON:ADN) a ‘buy’.

For a falling market, Citi’s top picks are Man Group and Ashmore.  For a rebound, all the asset managers should do well, but its top pick, with its high retail exposure, would be Jupiter.