% of AUM, 3i Group, alternative assets, Apollo Global, Argo Group, Blackstone, Carlyle Group, Cowen, developed markets, distressed assets, emerging markets, Fortress, Janus Capital, KKR, Mr. Market, Oaktree Capital, Och-Ziff, Record plc, special situations, Tetragon Financial
We’ve just witnessed the rather limp launches of Oaktree Capital & Carlyle Group (reflecting the current malaise in asset manager valuations), so it’s a good time to look more closely at the asset manager universe. But where to start? Well, the boring end of the spectrum, I guess:
Traditional managers are dime a dozen, with little to distinguish them. Most focus on developed markets (reflecting a rather timid clientele), and demonstrate no particular ability to outperform the market over time. They now face relentless competition from an ever-expanding ETF universe which, on average, easily matches them on performance and wallops them on fees.
I sense a lot of these managers may now be facing a tipping point… But I’m still amazed how well average/mediocre managers can perform – from a business perspective! It speaks to the power of their sales & marketing teams, and the corrupting lure of sales charges for advisers/brokers. It amazes me millions are still paying sales loads/up-front charges on fund investments! But I think the challenges to come will prompt another wave of asset manager consolidation – in terms of timing vs. performance that may prove a difficult investment theme to play… [There are others, but Janus Capital (JNS:US) is an interesting & obvious consolidation candidate, trading on an ex-cash 0.8% of Assets Under Management (AUM)].
The market (as in developed markets) probably isn’t going to help out either… Reflecting on that, I broke off and published another article, which I hope offers a good lead-in for this piece. The fiscal, debt and entitlement headwinds the developed markets face in the medium/long term are pretty relentless. In light of this, I offered 3 major investment themes that guide my portfolio allocation, and which I think offer a better combination of risk & reward. To summarize: i) a significant…in fact, your largest portfolio allocation should perhaps be directed to emerging & frontier markets, ii) focus your developed markets portfolio allocation on discounted asset/special situations, including private equity, event driven and distressed debt strategies, and iii) more generally/globally, focus on other absolute return opportunities that offer lower volatility & correlation.
An obvious play on these themes is to invest in alternative asset managers. The exception would perhaps be traditional managers focused on emerging & frontier markets. They’re still accessing a great growth opportunity, and more inefficient markets offer better scope for active management (to outperform passive ETFs). But I’d still prefer an emerging markets alternative manager if the right opportunity comes up…
First, let’s revisit asset manager fundamentals: The most important valuation metric’s always been % of AUM. On average, this ratio’s been a remarkably accurate indicator of underlying value, especially in M&A transactions. Yes, acquirers care little about margins & profits! That’s pretty unusual, but think about the dynamics of taking over a poorly performing asset manager: Of course you’ll need to lock down some key employees, but otherwise you’ve already got a back office, a research/analyst department and a sales & marketing team…
Yeah, there’s usually some short-term pretence at retaining employees – but inevitably it’s far more tempting to fire most of them and expand margins to industry standards, or way better! You’re really buying client assets – unless you really screw it up, these usually prove pretty ‘sticky‘. And for once, the other much quoted aspect of M&A actually appears true. Not only can you achieve dramatic cost savings, you also have the perfect opportunity to cross-sell and enhance returns from your sales & marketing efforts – yes, ‘revenue synergies‘!
All this means you can (usually) ignore earnings, and focus on buying at a discounted % of AUM. All v dependent, of course, on buying a manager who can actually retain & grow AUM… This requires good investment returns, or great sales & marketing (to be cynical), or both! Left unchecked, a declining AUM can easily turn into a devastating cycle for a manager. But if you buy at a cheap price, and don’t get crushed by a declining AUM, Mr. Market or an acquirer will almost inevitably offer you a standard/premium valuation at some point.
But what’s a decent price, or discount? In my experience, traditional asset managers average out between 2.25% to 3.25% of AUM, while alternative managers command, say, 7.5%+ of AUM. Many manage both types of assets, so a blended rate may also make sense. Be wary of traditional bond or CLO/CDO managers (who often tout themselves as alternative), or any type of bond assets under management. They usually earn much lower fees, and valuations… Only a smaller subset of distressed debt managers deserve premium alternative manager valuations.
btw Before somebody corrects me, the alternative guys can attract far higher valuations on occasion, but then I start getting uncomfortable. I guess I’d buy alternative managers at a discount to 7.5%, but I wouldn’t necessarily sell them there. But plenty of readers may ask why should they blindly accept these rules of thumb? And I also get uncomfortable relying on market wisdom, no matter how sound/conventional it appears – reminds me of the joke, ‘AAAs were great…until they weren’t!‘ Let’s drill down, and test the conventional wisdom:
First, asset managers have a well defined revenue model. Asking for 1-2% of assets as a fee, and perhaps 10-20% as an incentive, has seemed like a reasonable proposition over the centuries. And I do mean centuries – examine commercial history back in Roman, or even Babylonian, times and I guarantee you’d find similar fee and/or incentive arrangements. Maybe it’s simply down to innate human fear & greed - we dream of great investment returns, but are terrified of losing our savings. Then an authoritative and charismatic figure shows up offering us reassurance & returns, and all for a small fraction of what we hope to make..!
So, unlike most businesses, you don’t have to fight much about fees (or prices). What a nice life! And the nature of the model almost guarantees you a great margin on those revenues. OK, I can’t totally defend/explain margins. After all, how can I definitively argue a certain business model or industry will earn/deserves a particular margin over the long term? But the asset management industry has so many inherent advantages… It requires precious little start-up capital. You’ve virtually no capex or investment of any kind. You only need a small staff and space, and your costs are relatively fixed. You’re selling a valuable professional service. Once you raise assets, your near/medium term revenues are v predictable. You enjoy increasing economies of scale – running $10 billion has v little incremental cost vs. a $1 bio of AUM. Should I go on?!
Considering all the above, it shouldn’t surprise you to hear any damn fool manager can earn a 10-20% operating margin. And a top-notch manager can even command a 30-40% margin. You might presume alternative managers do even better, but don’t forget their compensation (& other) expense is far higher. On average, I reckon they earn similar/slightly better margins vs. top-notch traditional managers. They also have far more volatile margins, which tends to suppress the market multiple (in relation to operating profits) they’re awarded. All in all, I’d peg the average manager on a 25% margin, which normally deserves a 2.5-3.0 Price/Sales multiple.
OK, we’re at the heart of the equation now! A traditional manager usually charges a 1% of AUM fee, and is valued at up to a 3.0 Price/Sales – so a 2.5% to 3% of AUM valuation makes perfect sense! An alternative manager can earn a 1-2% fee, and (assuming an avg. 12.5% investment return) should make another 1% incentive fee (after hurdle rates etc.). That’s a total 2.5% of AUM in revenues, and the same 3.0 Price/Sales equates to a 7.5% of AUM valuation. OK, that’s our sanity check complete! Obviously each manager has their own unique story/valuation, but big picture these metrics really work: 2.25%-3.25% of AUM for traditional managers and 7.5%+ of AUM for alternative managers.
One proviso before moving on: Despite the positives, asset managers are still a geared play on the market. If a manager has a bad year, it’s like 3 big strikes against them: a) AUM declines due to negative investment returns, b) AUM declines due to client redemptions, AND c) sentiment’s likely to slap a lower valuation on their resulting AUM & revenues. Ugh, that’s quite the triple whammy! You may want to invest in v different managers, and limit your total portfolio allocation, in light of this increased risk exposure.
I also like to get more bang for my buck by finding: i) a great story – exposure to emerging markets or European distressed assets, for example, ii) a great stock – a well-run manager with a great investment record, and iii) a great price – a cheap % of AUM valuation, ideally with plenty of surplus cash.
Yes, a tall order, I know! As I’ve written before, faced with that kind challenge (and portfolio ‘rationing‘), I absolutely want to assess and rank ALL alternatives before I can even try to make any smart investment decisions. This is a first step in that process… OK, some notes before we look at the menu:
– Just a first pass, I’m trying to recall all managers with any type of alternative assets under management. I might have missed a few, if you’ve any reminders?
– I’ve ignored sub-10 million mkt caps, and stuck to developed market listings. I’ve also ignored Australia – I don’t want any exposure there right now
– I’ve used latest AUM, but tried to exclude uncommitted (i.e. non-fee earning) capital for alternative managers (an interesting source of future AUM, though)
– All valuations are basically on an enterprise basis, i.e. on an ex-net cash basis: That is, [Market Cap – Cash – Investments + Debt] / AUM = % of AUM
– Remember, this is v rough & ready! I generally haven’t stripped out minorities, or a manager’s own investments in their AUM. I have tried to exclude any balance sheet fund consolidation I see, but please recheck all figures!
– Figures for each manager are in the currency of their ticker
|Manager||Ticker||Price||AUM (bio)||Net Cash & Inv (mio)||Net % of AUM|
|Gottex Fund Mgt||GFMN:SW||2.56||7.02||47||0.4%|
|Integrated Asst Mgt||IAM:CN||0.65||1.94||17||0.1%|
Well well, a pretty interesting list of 26 managers** to start fooling around with! I’m glad to see Argo Group near the v bottom of the list! It’s already a favourite portfolio stock of mine – here’s my latest writeup. The other negative enterprise stocks are intriguing also. Off the top of my head, though: a) I suspect 3i Group‘s valuation is a function of its v attractive NAV discount (and external fees simply mitigate a bloated expense structure), b) with Cowen, a marvelous alternative business (Ramius) is obscured by the obscene comp. cost of their investment bank/broker dealer, and c) some of the other low valuations may simply reflect a large level of traditional/bond assets under management.
Normally you’d hear from me about a new investment, but I first wanted to dig into the asset management business model and explain my valuation approach. I also thought this universe of alternative managers, and a first pass % of AUM ranking, would hopefully prove pretty interesting and useful for you too – while I do the same. Good luck with your research!
If you’ve any questions or feedback, I’d appreciate your comments & emails, of course. And hopefully I’ll have a full writeup for you on one or more of these stocks in due course..!
** PS: I left 4 managers off the list:
i) Tetragon Financial (TFG:NA): Primarily an investment fund now (but on an extraordinary 42% discount to NAV – well worth a look), but they’re building up a large asset management business.
ii) Record plc (REC:LN): Specializes in currency management which doesn’t lend itself to a % of AUM metric, and performance has struggled. Record’s still nicely profitable and valuation’s cheap, esp. on an ex-cash basis, so I’ll take a closer look.
iii) MPC Capital (MPC:GR) & HCI Capital (HXCI:GR) (MPC has a 26% stake): These focus on fund creation/sales fees, and don’t highlight their AUM for some reason. I must dig deeper, but recent financials look a bit ropey – however, shipping‘s a big focus, so could be an interesting play at some point.