Investors who are looking for a contrarian play in financials, but who don’t want to assume the risks of the major banking stocks, might want to take a closer look at the asset managers. The industry has its challenges to be sure, but its miserable year-to-date performance has created some opportunities in stocks whose declining valuations have more than discounted the softening outlook.
Asset managers are on a pace to finish the year more than 20 percentage points behind the S&P 500 Index and with a worse return than even the Select Sector SPDR-Financial ETF (NYSE:XLF).
Click to Enlarge Year-to-date through Dec. 9, the industry stood at 91st among the 98 industry groups tracked by Dow Jones. Not surprisingly, there are a number of good reasons for this. The industry has been experiencing outflows because of poor market performance and rising competition from exchange-traded funds, making it unexciting in terms of its future growth prospects. Perhaps even more important, the asset managers are seen as being a leveraged play on the stock market as a whole — not where you wanted to be in 2011.
Click to Enlarge Once you look past the headline risk, however, this industry actually has a lot going for it, including its rock-solid balance sheets, outstanding profit margins, trough valuations, annuity-like businesses and — in some cases — high dividends. Industry earnings, in the aggregate, are projected to grow 9% annually during the next five years. At the same time, the majority of asset managers are trading with their lowest P/Es of the past decade aside from the crisis period of late 2008 and early 2009. The P/E graph of Franklin Resources (NYSE:BEN) is representative of most of the stocks in the group.
It’s certainly not a sexy industry, but the fundamentals are healthy overall — indicating that there has been some disconnect between price performance and the underlying story. The table below lays out some key metrics for the pure-play industry stocks with market capitalizations of more than $1 billion.
The asset managers are a large, diverse group, but the potential for further market volatility indicates the best strategy here is to stay defensive and focus on larger players that are gaining market share. Names such as Blackrock (NYSE:BLK), T. Rowe Price (NASDAQ:TROW), Invesco (NYSE:IVZ) and Franklin Resources — which just announced an 8% dividend increase and a $2 special dividend — appear to be a better option than rolling the dice on the Eaton Vances of the world.
While some patience is in order with the broader market in a tenuous spot here, this sector can work for investors in two ways over a longer, 12-month time frame. First, if the situation in Europe stabilizes and the stock market rallies in 2012, asset managers are likely to rebound sharply from their low year-to-date position in the industry performance rankings. Second, the sector already is so beaten up — and so far below its long-term valuation averages — that it still has the potential to hold up well in a market that is flat to moderately lower.
This combination of offensive and defensive characteristics is a compelling attribute at a time in which market performance is so sensitive to unpredictable external events. Add it up, and this out-of-favor industry has all the makings of a profitable hunting ground for investors in the year ahead.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities. Check out InvestorPlace.com’s other looks back at 2011 and ahead to 2012 here.