Wide Moat Business Type Series: Asset Managers

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Includes: ACAS, AMG, APO, AU, BEN, BLK, BX, CG, EV, IVZ, KKR, LM, OAK
by: The Value Pendulum

Summary

Asset managers boast structural competitive advantages such as brands and high customer switching costs, making them attractive wide moat investment candidates.

Asset management is a high-margin business thanks to operating leverage, which is a double-edged sword.

I found 59 listed asset managers on the U.S. and Asian stock exchanges, of which 37 of them are listed in the U.S.

This is the fourth article in my series on wide moat business types and I have chosen asset managers this time. The wide moat business types I have profiled in the past included airport operators, elevator manufacturers and theme park operators.

The Wide Moat Of Asset Managers

Most asset managers' moat lie with their brand and reputation. This is especially true for institutional investors, when they make the decision on fund allocation. The "nobody got fired for hiring IBM" mentality comes into play here, as the decision-makers, as salaried employees, will be reluctant to risk their careers by taking a big bet on unknown fund managers, even if their performance track record may be superior. Also, the well-known asset managers are typically larger, giving them the luxury of investing in marketing and other outreach activities to further enhance their brand names, resulting in a virtuous cycle where the leading asset managers continue to have a disproportionate share of funds raised across the industry. Furthermore, asset managers with a premium brand can do the equivalent of "line extension" in consumer products and create new funds (e.g. new strategies, new geographies etc) easily.

Some asset managers benefit from switching costs to a greater degree than their peers. Closed-end investment funds (e.g. private equity) require investors/limited partners to commit capital for a certain period (limit on redemptions) and provide the funds on demand. In comparison, for most open-ended hedge funds and mutual funds, investors can redeem their funds every quarter. Nevertheless, even for open-ended funds, there is still some stickiness and inertia involved.

Asset management is a high-margin, recurring revenues business. There are limited variable costs associated with running an asset management business. In the most extreme case, a single-manager boutique fund, where one outsources all the other functions apart from investment, is feasible and not that rare. With exception of certain fund managers (who collect either only management fees like mutual funds or only performance fees), the majority of asset management companies collect fixed management fees as a percentage of assets under management (AUM), regardless of performance. On top of that, they also get performance fees if they outperform and exceed a certain watermark; and they are not penalized if they underperform (except for fund redemptions).

Operating leverage is a double-edged sword for asset managers. When asset managers go on a home run and grow AUM by leaps and bounds, their costs do not increase in tandem. For example, if an asset manager's AUM doubles, it does not need to hire twice the number of investment analysts and back-office staff (some asset managers outsource some of their back-office functions). On the flip side, if there is a repeat of the 2008-2009 Global Financial Crisis, fund redemptions are going to happen in a big way (particularly for open-ended funds) and asset managers are faced with the dilemma of either retaining their staff for better days or working with a much leaner team.

Analyzing Asset Managers As Wide Moat Investment Candidates

An investment checklist prior to investing in any listed asset managers would probably look like this:

  • What is the asset manager's fund raising track record and capabilities? There are boutique asset managers whose performance will put the largest fund managers to shame, but they find it difficult to expand their AUM. In contrast, there are brand-name asset managers whose funds' performance are mediocre, and yet see significant fund inflows year in year out for their existing funds and having their funds oversubscribed in a short period of time. The difference lies in fund raising, which is the biggest contributor to growth in management fees.
  • How diversified is the asset manager with respect to asset classes, geographies and strategies? The top fund investors such as funds of funds and sovereign wealth funds want to work with fewer managers to streamline their operations and improve efficiencies, so the natural choice is to work with the large global asset managers with a wide assortment of funds dedicated to almost every asset class, geography and strategy conceivable.
  • How are the asset manager's funds structured in terms of fund life and redemption limits? This has been discussed extensively in the section on moats.
  • How does the investment performance track record of the asset manager look like? Ultimately, the performance has to match up to the reputation of the asset manager over the long run.
  • How are they rated by guys like Morningstar (NASDAQ:MORN)?
  • Is there any key man risk? For example, since the resignation of the "bond king" Bill Gross as Chief Investment Officer and the manager of The Pimco Total Return Fund, Pimco's flagship fund experienced significant fund outflows. The fund's AUM as end of February 2016 was $88 billion, compared with $98.5 billion and $293 billion in August 2015 and April 2013 respectively.

Seeking Asset Managers Listed In The U.S. And Asia

I found 59 listed asset managers on the U.S. and Asian stock exchanges, of which 37 of them were listed in the U.S.

The 15 largest listed asset managers ranked by market capitalization are as follows:

  1. BlackRock, Inc. (NYSE:BLK)
  2. Blackstone Group LP (NYSE:BX)
  3. Franklin Resources, Inc. (NYSE:BEN)
  4. AMP Limited (AMP AU)
  5. Invesco Ltd. (NYSE:IVZ)
  6. KKR & Co. L.P. (NYSE:KKR)
  7. Affiliated Managers Group, Inc. (NYSE:AMG)
  8. Oaktree Capital Group LLC (NYSE:OAK)
  9. The Carlyle Group LP (NASDAQ:CG)
  10. Eaton Vance Corp (NYSE:EV)
  11. Legg Mason Inc (NYSE:LM)
  12. American Capital Ltd. (NASDAQ:ACAS)
  13. China Everbright Limited (165 HK)
  14. Apollo Global Management LLC (NYSE:APO)
  15. Platinum Asset Management (PTM AU)

As a special bonus for my subscribers, they will get access to the full list of the 59 asset managers listed in the U.S. and Asia.

Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of wide moat investment candidates and value traps, which include "Magic Formula" stocks, wide moat compounders, hidden champions and high quality businesses, that I have profiled.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.