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For most investors, asset managers are to be avoided as they’ll do little more than tread water for the next six months to a year, but there are three companies worth buying in the sector right now...

by Simon Keane

There are only three companies worth buying in the fund management sector right now and they are Man Group, Liontrust Asset Management and BlueBay Asset Management, you can forget the rest.

Share prices for the sector have come off around 30% since the beginning of the year, ranging from a 44% collapse in the price of Charlemagne Capital to a 13% retreat from Henderson Group, so the worst may already be in the share price. Yes, there may be value there, but you’d have to be prepared to buy and hold these stocks for three years (the time it took for the last bear market to bottom out) if you’re taking this tack.

Buying cheap

For most investors, asset managers are to be avoided as they’ll do little more than tread water for the next six months to a year. If you are a long-term investor, Aberdeen Asset Management is the one to watch, as chief executive Martin Gilbert (see Rising Star, page 38) exploits depressed valuations to make some ambitious acquisitions.

The companies of any significance in the asset management sector can be broadly split into three categories. These are the traditional fund managers, who tend to run long-only funds (Schroders, Aberdeen and F&C Asset Management), the alternative asset managers (Man Group, Ashmore Group and BlueBay Asset Management) and a final category of the private client wealth managers (which includes Rathbone Brothers, Brewin Dolphin, Rensburg Sheppards and Charles Stanley).

A quick examination of this third group sums up the problems facing this sector, namely – falling markets eating into assets under management (AUM), prompting in turn rising redemptions as clients look to move their money out of equities and bonds into cash.

Since January all the private client wealth managers have seen AUM shrink by more than 5%. Between 31 December 2007 and 5 April, Rathbone Brothers has seen AUM drop from £13.1 billion to £12.4 billion – a fall of 5.3%. Over the same quarter, Brewin lost 7.9% of its managed funds, which fell from £21.6 billion to £19.9 billion.

Look across to Charles Stanley and the picture is not that much brighter, as its AUM went from £11.6 billion to £11.0 billion over the first quarter of 2008 – a reduction of 5.5%. We can only assume Rensburg Sheppards suffered the same fate – although it did not give an AUM figure for 31 December, we do know that assets shrunk from £14.4 billion to £11.5 billion – a drop of 20.3% – between 30 September 2007 to 31 March.

With a smaller asset base, the potential for these fund managers to earn fees is diminished, so we’ve seen some pretty hefty downgrades, as can be seen by the experience of alternative asset managers since the start of 2008. Katrina Preston from Lansbanki, for instance, has cut her earnings per share (EPS) forecasts for RAB Capital, Polar Capital Holdings and Charlemagne Capital by about 40%.

Long-term view

Now trading on single-digit price earnings ratios (PEs), some commentators have started pointing out that asset managers are cheap, but as we’ve mentioned you’d have to employ a long-term view to buy on this basis. With the FTSE All Share, having had its temporary spring rally, now moving back towards its March lows, investors should not be surprised to see the index plumb new depths.

Until now, the resources companies have been holding the market up but, with questions now being raised about the sustainability of huge profits experienced by the miners and a likely bursting of the speculative bubble keeping oil at $140, this part of the market is due for its own correction.

Some are speaking of this correction due in the autumn, as the Chinese authorities seek to moderate their economy’s breakneck speed after the Olympic Games in Beijing. Chinese demand has been driving much of the resources boom.

At today’s levels the FTSE is down 20% since its highs hit last June, whereas in the last bear market of 2000–2003 we saw the market fall 48% from peak to trough. Arguably, the challenges facing companies and the economy now (reduced availability of credit and rising inflation coupled with rising interest rates) are far worse than those encountered at the time of the technology bubble bursting.

Theoretically, alternative asset managers should be able to make money in both a rising and falling market, but the reality is turning out to be rather different. Index compiler Hedge Fund Research’s broad measure of the industry, the HFRX Global Hedge Fund Index, is just about struggling to remain above water, posting a 0.4% loss since the beginning of the year.

Money-back threat

But poor performance and rising redemptions are not the only challenges facing the hedge fund industry, as it is also suffering on the back of the de-leveraging under way in the wake of the credit crunch. Like Carlyle Capital Corporation – the now defunct, highly borrowed investor in US mortgage-backed securities – or Peloton Partners, it stands to be wiped out as cash-strapped banks ask for their money back.

Despite the challenges facing the hedge fund industry there have been some winners, and Man Group is most definitely one of those. Since the start of the year its key AHL Diversified fund, a portfolio run using quantitative processes, has risen by about 15%, and the result is Man has grown its AUM while all around have shrunk.

Liontrust is something of an anomaly in that it is a long-only fund manager that has managed to buck the market falls. In the year to the end of March the Liontrust First Growth retail fund has managed to gain 0.7% against a 7.7% retreat from the FTSE All Share. This fund’s performance will be a good proxy for how the rest of the group’s portfolios, and most importantly the institutional mandates, are performing.

Institutional investors are starting to catch on to this, and the company has seen fund outflows reverse to become inflows. The prospect of a bid, following the recent approach, adds to the attraction of Liontrust, but the out-performance is the primary attraction.

Overall, it is a poor prognosis for the fund management sector, which is likely to remain in the doldrums for at least another six months to a year. The time to short these stocks is past, meaning little interest either way, as shares tread water.

TOP ANALYSTS

Gurjit Kambo – Numis Securities

Up on alternatives

Kambo has covered financial stocks for seven years – firstly banks and more recently the asset managers.

Before joining Numis late last year he worked at Credit Suisse and HSBC. The 33-year-old trained as an accountant at PricewaterhouseCoopers (PWC), which he joined from university in 1996. Kambo did the obligatory three years working in audit, where he was part of a team auditing accounts of the investment managers.

Kicking off at Numis on 1 May with a 170-page note initiating coverage on nine asset managers, Kambo did particularly well to spot Liontrust. He flagged the company as a buy at 261p – near its year lows of 234.5p – since when the stock has risen 22% to today’s 319.5p.

Liontrust, which, like other long-only fund managers, has been suffering from heady fund outflows, is now widely accepted to be on a recovery path, with improving fund performance tipped to draw a line under a disappointing run. The shares have also benefited from a bid approach on 20 May.

Bar Liontrust, as a rule Kambo is more upbeat on the alternative asset managers. He has slapped either buys or adds on the emerging markets specialists (BlueBay Asset Management, Ashmore Group and Charlemagne Capital) and hedge fund groups (RAB Capital and Man Group).

Philip Middleton – Merrill Lynch

No April fool

Philip Middleton took his first analyst job in 1986 (on April Fools’ day, he recalls) and at 47 years of age is one of the more experienced of his peers. He started his career at Kitcat & Aitken before he and his team joined Smith New Court in 1990, which was later acquired by Merrill Lynch in 1995.

Middleton covers the traditional fund managers Schroders, F&C Asset Management and Rathbone Brothers, as well as the alternative groups Man Group and Swiss-quoted Partners Group. While he won’t be drawn on individual recommendations, he currently favours the ‘alternative space’.

Middleton, who prior to joining Kitcat & Aitken, worked for three years as a House of Commons researcher, believes asset managers will increasingly have to demonstrate their stock-picking skills.

With the advent of exchange-traded funds, investors can now cheaply track indices, forcing fund managers to differentiate themselves: ‘We will see more focussed long-only products, more risk taking, and some funds moving to different asset classes, such as agriculture and commodities or using derivatives,’ says Middleton.

Katrina Preston – Landsbanki

Useful grounding

A background in corporate finance (more recently at Hawkpoint) was, says Preston, a good springboard to becoming an analyst: ‘It helps your financial modelling and forecasting skills, you understand how deals are financed and think more about earnings accretion and dilution.’

After leaving Hawkpoint in 2002 having ‘hated’ the experience, Preston spent six months out travelling before coming back to the City as an analyst at HSBC, where she began coverage of the asset managers.

The 34-year-old moved to Bridgewell in 2004, which was subsequently taken out by Icelandic bank Landsbanki in 2007. Preston is generally upbeat on the asset management sector at the moment – to give you a flavour of this she and fellow financials analyst Ian Poulter (banks and specialist lenders) cover 28 stocks between them, with 14 on buy and ten as holds.

Her top pick is Brewin Dolphin, which, like all its peers, has been heavily sold down. Preston calculates that Brewin is currently valued at 2.7% of its discretionary AUM, when such companies should ‘normally’ trade on about 3% of discretionary assets. ‘So you’re getting the rest of the asset management and investment banking side for free,’ explains Preston.

BEST BUYS

Man Group – Hedge grows strongly

It is not only the long-only fund managers that have been suffering of late – hedge fund managers have also been struggling. In theory these funds should be able to make money in both falling and rising markets but in practice it has been a different matter. The HFRX Global Hedge Fund Index, which is a broad measure of how the industry has been performing, has only just about held its ground, down 0.4% since the beginning of the year.

Against this backcloth Man’s performance has been exceptional. The company’s key fund is AHL Diversified and it is up about 15% since the beginning of the year.

While Man’s long-only peers have seen AUM collapse since the beginning of 2008, the performances of AHL and other funds mean the group has continued to pull in money.

Since the start of the new financial year to the end of the first quarter on 31 March, Man’s AUM rose by $2.3 billion from $71.7 billion to $74 billion. Fund performance contributed $0.8 billion to this expansion. Of the remaining $1.5 billion, $0.9 billion came from net sales, with the residual $0.6 billion due to currency movements. Strong performance has continued into the second quarter, with AUM up further still to stand at their current level of around $78.5 billion.

BlueBay Asset Management – Opportunity knocks on profit warning

After coming off sharply following last month’s profit warning, investors are presented with a buying opportunity in bond fund manager BlueBay Asset Management.

The cause of the profit warning was a fall in performance fees, which is understandable given the state of credit markets at the moment. If you look through this hiccup the real story is that fund inflows remain strong, so it seems BlueBay’s clients remain, for one interested in bonds and secondly are keeping the faith with BlueBay’s managers to steer them through the turmoil.

Currently at 256.5p, the shares are off 22% from their 330p high prior to the alert, opening a window of opportunity.

Liontrust Asset Management – Increasing AUM

May’s finals confirmed that Liontrust Asset Management had managed the rare feat for a long-only fund manager of actually increasing AUM this year – not bad given that the FTSE All Share index has retreated by 14% since January.

Liontrust’s shares have started to reflect this improving trend and, at today’s 259p, are up 11.5% since April’s lows of 232.25p. While AUM initially fell from £5 billion at 31 December to £4.7 billion at 31 March, by 23 May they had hit £5.2 billion.

The prospect of three years of outperformance appears to be drawing interest back to Liontrust. Things are looking up after a poor 2004 and 2005 – as evidenced by the statistics for the Liontrust First Growth retail fund, which underperformed the market in both those years. In both 2006 and 2007 Liontrust First Growth beat the market and in the 12 months just gone to 31 March 2008 it managed to post a gain of 0.7% versus -7.7% from the FTSE All Share.

The performance of this fund will be a good proxy for how the group’s institutional mandates are performing. Institutional mandates are the largest source of AUM and potentially the most profitable business, given that they attract performance fees.

STEER CLEAR

Brewin Dolphin – All Share avalanche hits

Retail investors are the most flighty of the lot when it comes to bear markets. The worry has to be that the 20% fall in the FTSE All Share since last year’s highs will have hit sentiment hard among Brewin’s clients and the moderate outflows we’ve seen so far could turn into a torrent. The worry is that as revenues fall along with AUM it could have a disproportionate impact on the bottom line.

Justin Bates, an analyst at independent broker Daniel Stewart, has studied Brewin’s performance over the last equity market downturn between 2000 and 2003. During this period, Bates found that revenues dropped by 20%, but the company’s high operational gearing meant this translated into an 88% fall in operating profits from £21.9 million to £2.7 million.

The latest update on AUM at May’s interims showed that the managed funds segment of Brewin’s client base dropped by 7.9% between 31 December and 30 March, from £21.6 billion to £19.9 billion. That’s not bad given a fall of about 12% in the FTSE All Share over this period but, with equity markets likely to take a downward tack this year, clients’ loyalty may be tested yet.

F&C Asset Management – Poor record

Like the other asset managers, this company has seen its shares correct since last summer, but its stock is still trading on a higher rating to peers. At their current 149.3p, the shares are on a multiple of 15.1 times’ earnings – that’s expensive compared with peers such as Schroders (which is on a PE of 11). Part of the reason for this could be the prospect of a bid, following news that 52% shareholder Friends Provident plans to dispose of its holdings – but the question has to be: who would want F&C?

The group’s record as an asset gatherer has been poor – after looking at three years of data to see who in the industry is best at growing AUM, independent broker Landsbanki recently concluded that F&C is among the bottom three. At March’s year-end results the company admitted its three-year programme – targeting EPS growth of 50% between 2007 and 2009 – was in question as the ‘market and corporate situation creates uncertainty’. AUM for the year fell from £104.1 billion to £103.6 billion.

The prospect of a bid for F&C is not looking good, in which case the shares don’t deserve their premium rating and still have further to fall.

Rathbone Brothers – Comparatively overvalued

Rathbone has been resilient compared with its private client wealth management peers, recording a 5.3% drop in AUM for the first quarter of the new financial year. Such a retreat is also not bad, given a comparable 12% fall in the FTSE All Share over the same time period.

The only problem with Rathbone is that it remains overvalued compared with its peers. The stock is currently trading on a PE of almost 11. This compares with the 9.5 PE of Charles Stanley which, with AUM retreating 5.5% in the first quarter, is experiencing a similar rate of attrition to its fund base.

Rathbone, having seen its share price retreat 16% in the year to date, has recorded the smallest share price drop of companies in the sector, with Brewin Dolphin coming off 32%, and Rensburg Sheppards and Charles Stanley off 18%. It seems likely that this stock has a little bit further yet to fall.

RISING STAR

Man of action

Courage and vision are the hallmarks of Aberdeen’s chief executive

Martin Gilbert, chief executive of a FTSE 250 company that he co-founded 25 years ago, is a star on the rise again.

Spin the newsreel back to the last bear market and the reputation of Gilbert’s creation, Aberdeen Asset Management, was laid low by association with the collapsed split capital trust sector. Today, however, is a totally different story and Aberdeen has found its confidence again – most recently demonstrated by May’s acquisition of Goodman Property Investors (GPI).

I put it to the 52-year-old that this might not be the best time to be increasing exposure to UK commercial property, and he admits he may end up ‘looking really stupid’. But the fact that Gilbert has got Aberdeen back into growth mode perhaps says more about the prospects of the business than any short-term hit it may take on property. And who knows, with share prices for the quoted property companies off 40%, the bad news may already be in the price.

The Aberdeen of today is totally different from the Aberdeen that, along with 17 other investment firms, coughed up £194 million in 2004 to get the Financial Services Authority (FSA) to drop its investigation into split capital trusts.

That settlement helped draw a line under the ‘splits’ episode but Gilbert, one step ahead, had by that time already laid the ground for the new Aberdeen by selling its unit trust business the previous year to New Star Asset Management.

Now out of the retail funds sector and the area of keen focus in the FSA’s splits investigations, Aberdeen was free to make a clean break of building up its institutional business.

Ready for the next stage

The acquisition of Goodman is perhaps the final piece in the jigsaw of the new Aberdeen: Gilbert says acquisitions are off the agenda for now – creating as it does a fund management business with AUM now split broadly equally between equities, fixed income and property.

No-one can expect much from a fund management business today, as equity markets continue to fall and credit spreads on bonds and yields on property widen still further, but the foundations are there for the next recovery. When this comes Aberdeen would be the most likely company in the sector to join the FTSE 100.

Aberdeen’s fixed income business has its genesis in another acquisition – or more accurately a series of smaller acquisitions, when the company selectively picked off parts of Deutsche Asset Management in 2005. The acquisition of the Deutsche businesses, which largely comprised the former Morgan Grenfell Asset Management operations acquired by Deutsche Bank in 1989, tripled Aberdeen’s AUM overnight from aproximately £25 billion to around £70 billion.

Gilbert and his team had repeated the trick that created the company’s equities business back in 1988 with the purchase of Sentinel Asset Management. Acquired with Sentinel was Hugh Young, the respected Asian equities specialist who has built Aberdeen’s Far East business into a mainstay of the equities arm.

With AUM around £114 billion at the last count, Aberdeen is now the second-largest quoted traditional fund manager after FTSE 100 company Schroders.

While Gilbert, who never quite made it into the FTSE 100 ahead of the 2000-2003 bear market, plays down the significance of moving into the top flight, it must surely be a secret ambition. He’d only have to double today’s £950 million market cap – surely possible for someone who started nearly from scratch in 1983.

30 second – Aberdeen Asset Management

• Aberdeen was formed in 1983

• Acquired Sentinel Asset Management in 1987 and with it star manager Hugh Young

• In 2003 sold retail asset management business to New Star Asset Management

• Purchased bond businesses from Deutsche Asset Management in 2005

CHARTING THE SECTOR

Battling for its head & shoulders

As it teeters on the verge the sector has a precipitous view down to 2003 lows

by Simon Griffin

Since it based in early 2003, the sector has risen in value by over two-and-a-half times to the peak in mid-2007, a move Fibonacci fans might have foreseen as it closely reflected the 1.618 ratio projection of the 2001 to 2003 decline.

Yet the decline from the peak has seen some 30% wiped off the value of the sector on a capitalisation-weighted basis, with a move down to test bull trendline support in late March.

The subsequent bounce seems to have petered out, following an inability to break above the descending 200-day average and a retest of support from the trendline looks likely to follow.

Where next?

The main worry is that we are completing a large head-&-shoulders pattern, the ‘neckline’ of which is currently pencilled in some 6% below current levels. If this line fails to support and the decline continues a significant further drop is evidently to come, perhaps enough to see the market almost back to the lows of 2003.

There would be chances on the way for a rally and such an outlook might prove too pessimistic. Indeed, until the neckline is broken the pattern is not complete and, though rare, can prove to be a continuation formation rather than a turning point.

However, to muster anything approaching a bullish outlook, the sector would need to climb clearly above its early June high and better still provide the means for the 50-day average (blue line) to move above the 200-day average. This seems a tall order at present.

Man Group (EMG)

SELL – 611p

TARGET – 455p

STOP LOSS – 640p

Renowned for its esoteric investment strategies, Man Group’s shares bucked the 2000-03 bear market, and have risen 26-fold in the past 12 years. The FTSE 100 little more than doubled.

A long-term growth path, as defined by my trendline, currently stands near 410p and any previous encounter has prompted a renewed upside phase.

The two-year bull channel endured until this time last year but has been broken, and a sideways, ranging stance has developed. The May 2006 high near 455p seems to define the base, with the test of this level last August showing the high volume of a selling climax. Congestive resistance near 595p has until recently contained the shares.

Recently an assault on year-old highs has breached this latter level. If apparent current resistance proves too strong, then now would be a good chance to sell, as expectations would be for a return to the range and a retest of support from its base near 455p.

But if the shares climb above 634p, we must see the sideways phase as consolidation that will boost the shares. They have bucked the sector until now, but the proximity of such key levels allows traders to stop and reverse a short trade that proves wrong, a trade favoured as the sector looks so bearish, with the expectation of a test of the long-term bull trend in due course.

Schroders (SDR)

SELL – 916p

TARGET – 605p

STOP LOSS – 975p

The chart goes back some 14 years and suggests the shares do not like life above £14 for long. See last autumn, when the share price failed credibly to attack the 2000 £15.90 high.

Failure to break an old high suggests a rising trend ending. This came as the shares tested the top of the channel range they had largely stayed within for the previous four years. These factors should have prompted the expectation of a rollover to test support from the channel base line, completing a double top pattern that then targeted a 400p drop toward a test near 800p.

The channel base did not halt the decline, which a test of the channel extension line (lowest parallel black line) ended. The bounce that followed in April has been quite muted and support from the line has been retested.

There seems little reason to expect the line to hold this time round and an early test of support near 800p looks more likely. A slip below this would suggest further weakness toward 600p. Realistically only a climb back above £11 would justify any resurgent bullish stance.