New twist: Intech outflows pulling down parent Janus

Analysts’ enthusiasm for Janus Capital Group is waning because of subsidiary Intech’s third-quarter outflows, a reversal of fortune from earlier in the decade, when the quant unit’s breakneck growth helped prop up its struggling parent.

A number of institutional clients and investment consultants remain willing, for now, to stick with Intech, which averaged $12 billion a year in net inflows between 2004 and 2006. However, if the firm’s volatility-capture model can’t turn the corner in the coming quarters after a stretch of weak performance for key Intech strategies that began in 2006, some said that their faith could be shaken.

In the latest quarter, Intech suffered $2.5 billion in institutional client outflows, reflecting weak returns for the firm’s U.S. large-cap-growth-equity strategies. Those outflows more than offset $1.3 billion in inflows for Janus strategies and $600 million in inflows for Perkins Investment Management LLC, the group’s value-equity boutique.

Intech had $47.3 billion in assets under management as of Sept. 30.

That unexpected news helped knock Janus’ stock 6.3% lower on Oct. 22, a day when the S&P 500 rose 1.1%. Research analysts responded by trimming their price targets, and earnings and net inflow estimates for Janus.

The Goldman Sachs Group Inc. analyst Marc Irizarry said in a research note the day after Janus’ Oct. 22 earnings announcement that the “negative surprise” from Intech should spell a slower recovery of the group’s operating margins than could have been anticipated from the strong results at Janus and Perkins.

In a recent interview, Robert Garvy, Intech’s chairman and chief executive, acknowledged that his company’s two biggest U.S. large-cap-growth-equity strategies — the $10 billion large-cap growth and $6.8 billion broad large-cap growth — were lagging their respective benchmarks for the three- and five-year periods ended Sept. 30.

Those numbers, while regrettable, also can be seen as a measure of Intech’s success at limiting losses during a period of extreme market stress — which people often mistakenly assume is a perfect environment for the firm’s “volatility-capture” model, he said. In reality, the amount of volatility that Intech’s model demands is fairly modest, and the market mayhem of the past year or so wasn’t conducive to the strategy, Mr. Garvy said.

He expressed confidence that those strategies will return to their historical pattern of outperformance.

Topping its benchmark

Even with its recent underperformance, the large-cap-growth strategy has outperformed its benchmark — a blend of the S&P 500 and the Citigroup Growth Index — by an annualized 462 basis points since its inception in 1993. The broad large-cap-growth strategy has outperformed its benchmark, the Russell 1000 Growth Index, by an annualized 147 basis points since it began in January 2001, according to eVestment Alliance.

Those strong returns helped make Intech an industry star, just as Janus’ growth-equity strategies were facing heavy outflows following the bursting of the technology bubble in March 2000. For 2006 alone, Intech’s $12 billion of net inflows helped Janus Capital report a net gain of $2.3 billion in new inflows for the year.

On Janus’ recent earnings conference call, Mr. Garvy said: “Patience is a virtue in this kind of circumstance” for a strategy such as Intech’s.

A number of Intech’s institutional clients say that they buy that argument.

Intech’s mathematical model works best in markets with sharp disparities in volatility among different market sectors, and the markets of the past year or two have been too “noisy” to reach any definitive conclusions about the strategy’s long-term prospects, said Jeffrey W. States, former chief investment officer of the $6 billion Sacramento County (Calif.) Employees’ Retirement System, which has about $100 million in the large-cap strategy.

“We are willing to give them time to recover,” he said.

Earlier this month, Mr. States joined the Nebraska State Investment Council as state investment officer.

Another pension fund client of Intech’s large-cap-growth strategy, who asked not to be identified, said that all quant strategies — reliant as they are on stable market factors — have been flummoxed by the volatility of capital markets over the past year or two. Anyone dropping Intech now runs the risk of getting out at exactly the wrong time, Mr. States said.

Still, a number of institutional investors decided to take that risk recently, even though Mr. Garvy noted that only half of Intech’s $2.5 billion in outflows reflected terminations. Re-balancings and partial withdrawals for liquidity purposes accounted for much of the remainder, he said.

The board of the $7.1 billion Los Angeles Water & Power Employees’ Retirement Plan terminated Intech from a roughly $250 million large-cap-growth mandate in August.

Neil Rue, a managing director with the plan’s investment consultant, Pension Consulting Alliance Inc., said that the decision reflected doubts as to whether the Intech strategy could deliver above-benchmark returns over market cycles.

Rough performance for key Intech strategies since 2006 in a variety of different market environments has focused attention on how well the firm’s model works, said Jack Marco, chief executive of investment consultant Marco Consulting Group.

“We haven’t recommended terminating them,” he said, adding that Marco hopes to see Intech’s performance take a turn for the better over the coming quarters.

Questionable ‘miracle’

“The Intech miracle is now subject to question,” said another investment consultant, who asked not to be identified. The issue isn’t so much that Intech’s model didn’t work well when cross-sectional volatility got washed away during the crash and rebound; rather it’s the lack of progress one would have hoped to see as cross-sectional volatility re-emerged over the past one or two quarters, he said.

Mr. Garvy conceded that net outflows from Intech’s growth-equity strategies could worsen if performance doesn’t improve soon, but he said he would be surprised if the third quarter’s heavy outflows set the tone for the next few quarters.

A number of research analysts late last month predicted that outflows from Intech will continue to weigh on Janus next year.

An Oct. 23 report by Bank of America Corp./Merrill Lynch & Co. Inc. analysts Cynthia Mayer and Guy Moszkowski predicted another $2 billion in net Intech outflows for the current quarter, followed by another $4 billion of outflows next year. However, the analysts still recommend that investors buy Janus stock, with forecasts of even stronger combined inflows of $6.8 billion for Janus and Perkins strategies.

A recent report by Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC, meanwhile, predicted that it could take a while for Intech to turn performance around, with net outflows of $4.6 billion likely next year, followed by marginal outflows of $100 million in 2011.

Douglas Appell is a reporter for sister publication Pensions & Investments.

Related Topics: Janus Capital Group