U.S. stock funds performed strongly in the third quarter — but the shares of the firms that manage them did not, new analysis shows.
That's because the strong domestic equity returns were partly offset by weakness in global stocks and fixed income, as well as weak inflows, wrote Robert Lee, head of asset management research at Keefe, Bruyette & Woods, in the investment bank’s third-quarter preview of traditional asset managers.
Asset management stocks are cheap, trading at 10 times 2019 earnings estimates and a median 11 percent free-cash-flow yield, according to KBW. Lee expects valuations to remain low for the foreseeable future, as these firms continue to grapple with numerous challenges.
“Unfortunately, we expect there will be little let up in the pressure on valuations as investor apathy remains high, and concerns over organic growth, profitability, and asset returns remain intense,” Lee wrote. “Given that we don't expect these concerns or issues to be resolved over the coming months, broadly speaking we see few catalysts for meaningful improvement in valuations.”
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In general, KBW expects that most managers continued to experience outflows in their active equity strategies in the third quarter. At the same time, Lee projects that fixed income, as well as non-traditional and alternative funds, attracted new money during the period.
Still, investors are taking a dim view of the sector overall.
“Given that the declines in stock prices since the end of 2Q have generally been more severe than any change in AUM, in our view investors are clearly pricing in additional pressure on asset returns and anemic growth,” says Lee.
But they may be going too far. Lee writes that investors are pricing some stocks as “junk equity,” and he believes the negative sentiment is overdone, given that some of these firms are capable of producing at least modest organic growth over the next year and leverage levels are modest or declining.
That means these stocks could bounce back sharply if forecasts for asset flows turn out not to be as dire as predicted, he wrote.
AllianceBernstein, BlackRock and Brightsphere Investment Group are KBW’s top picks in the sector. KBW says it’s a good time to buy BlackRock, the largest asset manager in the world.
“BLK…offers a better risk/reward given its strong positioning in faster-growing parts of the industry (ETFs, Passive, Global, Alternative and Fixed Income) and scale, all of which is helped by its unique technology footprint in BlackRock Solutions,” wrote Lee.