About 10 years ago, there were a few articles written that pointed out the intriguing fact that an investor would have been much better off buying shares of fund companies than their funds.
Some then concluded that it reflected that fund company management’s true loyalties were to stockholders rather than to fundholders. Others saw it as proof that funds were just for naïve small investors who were ripe to get ripped off.
To be sure, there are some areas where the interests of fund company stockholders and fundholders are aligned. To produce strong stock appreciation at an asset manager you almost certainly need to produce superior long-term performance for fundholders first. In other ways, those interests conflict.
If a fund company holds off on closing a fund in order to garner more assets, it boosts its earnings in the short run at the very least, yet is sacrificing long-term returns for fundholders. Likewise, a fund company sees a short-term benefit to keeping fees high, which detracts 1-for-1 from fundholders’ bottom line. However, in the long run, high fees inevitably lead to poor long-term performance and, in turn, redemptions that cost the fund company money.
Some fund company shares have been poor performers in recent years, so I was curious if the tables had turned on asset manager stocks versus funds. I looked at 10-year performance through Oct. 31, 2011, of asset-manager stocks, their funds, and their stock funds to see how things shook out. I excluded fund companies where the fund business is a small sliver of a giant bank or insurance company as you can’t really read much into that. That left me with 12 fund companies that provided a valid comparison.
This time out the tables had indeed turned. At eight of the 12 fund companies, the funds—whether pure equity or all funds—beat the company shares and quite handily, too. The most extreme case was Janus (JNS) where the average fund returned an annualized 5.9% while the stock lost 9.9%. (All return figures here are annualized.) The figures are very similar if you limit it to stock funds (5.9%) or asset weight all funds (5.1%), or just stock funds (5.0%). Likewise, shares of AllianceBernstein (AB) lost 2%, while its average fund returned 4.9% and the average stock fund returned 5.4%.
On the flip side, T. Rowe Price (TROW) had the best stock performance and the greatest outperformance of stock versus funds. Yet its fund performance was also the best. T. Rowe shares returned 15.7% annualized and its funds returned an asset-weighted 6.8%. The examples of T. Rowe Price and Legg Mason illustrate that there certainly is a positive link between fund performance and fund company stock performance. Serve fund investors well and you’ll draw assets and likely boost your stock performance.
While Janus’ example would seem to contradict this case, it really doesn’t. 10 years ago, expectations for Janus stock and funds were sky high as indicated by fund flows. Yet Janus bitterly disappointed with poor losses in the 2000-02 bear market and then by getting ensnared in the market-timing scandal. That led to huge outflows. On the positive side, the firm has actually delivered pretty good results the past 10 years–only it hasn’t spurred much inflows and that’s reflected in its stock price, which now reflects very low expectations. (I can see why Greggory Warren has it rated 4 stars and why John Rogers owns the stock in Ariel Fund (ARGFX).)
The other driver here that has little to do with how well shareholders are treated is that asset managers’ shares naturally work as something of a leveraged play on the stock market. When the markets are roaring, fund company fee growth soars because you have a positive loop of appreciation and inflows that means asset growth exceeds market growth. Then along comes a crummy market decade like we’ve just been through and weak returns lead to low appreciation and outflows or tempered inflows at the very least.
Which will win the next 10 years? Beats me.
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