These are difficult times for the mutual fund industry, which makes consideration of publicly traded fund companies as investments particularly nerve-racking.
The stock market's rally since the March 9 low has been kind to most of the stocks fitting into the category, but some reality should set in as the market absorbs the latest first-quarter-earnings data.
For an industry that saw total assets under management fall last year by $2.4 trillion, to $9.6 trillion, the winners could be the firms that lost the least.
Just as investors jumped into fund company stocks as the market rallied last month, the trend seems to favor relative strength. The point was driven home last week when San Mateo, Calif.-based Franklin Resources Inc. (BEN) reported a 70% drop in fiscal second-quarter net income to $110.8 million, from $366.1 million a year ago. This was an im-provement over Franklin's fiscal first quarter, ended Dec. 31, when profits fell by 77% from a year earlier.
But over the seven-week stretch since the March market low, Franklin Resources stock has gained 52.6%. This compares with a 29% gain by the Standard & Poor's 500 stock index over the same period.
From the start of the year through April 29, Franklin Resources' stock was down 5.5%, while the benchmark fell by 3.3%.
Coming off the carnage of the second half of last year, it shouldn't be surprising that a number of fund companies are reporting improved revenue and earnings. Among those companies that have shown im-provement are Baltimore-based T. Rowe Price Group Inc. (TROW), New York-based Al-li-anceBernstein Holding LP (AB) and New York-based
BlackRock Inc. (BLK).
The basic fund company business model makes them logical leaders in market rallies. Since the majority of their operating costs are fixed, the leverage kicks in during rising market runs, which inflate the assets under management from which revenue is derived.
“These are high-beta stocks that have historically been early movers that will lead the market and financials in particular,” said Michael Kim, an analyst with Sandler O'Neill & Partners LP in New York.
But the concern is whether some of the stocks in the group have already gotten ahead of where they should be. “These stocks have meaningfully outperformed, and it's a bit too far, too fast,” Mr. Kim said. His note of caution is based on the reality of how far assets have declined across the fund industry over the past 18 months and what these companies have done to address the issue of tightening profit margins.
Money market funds, for example, have emerged as an albatross around the neck of some firms, as interest rates have dropped to levels that make the cash accounts difficult to operate at a profit.
According to Strategic Insight Mutual Fund Research and Consulting LLC in New York, money market funds, as a percentage of overall mutual fund assets, grew to 41% in March, from 30% a year ago.
Meanwhile, equity funds dropped to 40% of all fund industry assets, from 55% a year ago. And assets in fixed-income strategies climbed steadily to 19%, from 15% a year ago.
Denver-based Janus
Capital Group Inc. (JNS) has started unwinding its institutional money market business.
Janus, which manages $111 billion, is among the group's strongest stocks since the March bottom. Over the seven-week rally, the stock gained 136% and was up 16% year-to-date as of April 29.
“The fund companies have been a bit of a mixed bag,” said Gregory Warren, an analyst with Morningstar Inc. in Chicago.
“Most of the companies are trading at about where we think they should be, based on discounted-cash-flow estimates,” he added.
The Morningstar analysis in-volves projecting income and operating revenue, and then discounting it back to a value based on cash flow.
By that measure, Janus would be fairly valued at $7, which is about $2.90 below where it was trading as of April 29.
Morningstar recommends in-vestors consider selling Janus in the $14 range, which allows the stock another 41% worth of upside.
But before getting too excited, investors need to remember that the industry benefited during the quarter from the strength of January, historically the biggest month for inflows.
And it would be a mistake to ignore the drag of reduced 401(k) plan matching contributions as companies continue to cut costs.
A new Investment Insights -column appears every Monday on InvestmentNews.com. E-mail Jeff Benjamin at [email protected].
