by Will Ashworth | May 13, 2013 12:10 pm
Despite what an absolute glut of mutual funds might otherwise indicate, there’s actually quite a dearth of publicly traded pure-play issuers on the market. Large asset managers such as BlackRock (NYSE:BLK) provide many kinds of advisory services in addition to mutual funds, making a pure play difficult to find.
However, there are at least a few that obtain a majority of their revenue from mutual funds. Here are four solid picks of the litter, ranging from large cap to microcap:
If you’re looking for large-cap mutual fund stocks, look no further than California-based Franklin Resources (NYSE:BEN).
Franklin has approximately $824 billion in assets under management. While its quarterly earnings report doesn’t break out AUM in enough detail to know exactly what percentage is composed of mutual funds, its fiscal 2012 10-K does indicate that mutual funds accounted for 80% of AUM, so I’ll assume it finished the end of March with $659 billion in mutual fund AUM.
The higher the AUM, the more revenue the asset managers can generate. In Q2, Franklin’s AUM increased 14% year-over-year, boosting operating income by 18% to $729.4 million. More importantly, its operating margin increased 190 basis points in the quarter, up to 36.2%. If BEN can keep boosting the operating margin over the next two or three quarters, it will be more profitable than it’s ever been on an operating basis, which makes sense given the economies of scale that are in play.
Franklin is the largest cross-border fund manager in the world (cross-border funds source less than 80% of their assets from investors in any single country). Interestingly, Italy is Franklin Resources’ largest market outside of the U.S. and Canada, with $32.7 billion in AUM. Of that, approximately 77% is retail money. According to Franklin, mutual funds have a 22% penetration rate (mutual fund assets as a percentage of household financial assets) in the U.S. market. Assuming the same penetration rate in Europe and Asia, it has an excellent opportunity to grab a piece of $12 trillion in assets.
If you like your investments large, you can’t get much better than Franklin Resources.
Pure-play mutual fund companies tend to be small or large, but usually not in between. However, Federated Investors (NYSE:FII) is a good candidate because of its business model, and the fact that its stock seems reasonably cheap despite being up 79% since the end of 2011.
Federated offers 137 funds to clients, including 50 of the money market variety, 52 fixed-income and 35 equity funds. At the end of March, its mutual fund AUM was $310 billion, or 83% of its total.
If you’re looking for excitement, this isn’t your investment. Sixty-six percent of its AUM are in money market funds; another 11% in fixed-income. However, while equity funds account for only 6% of AUM, they did generate 27% of the firm’s revenue in the quarter. Its Federated Kaufmann Fund (MUTF:KAUAX) alone is responsible for 10% of its overall revenue. Although Morningstar gives it just two stars, its long-term performance has been decent, if not spectacular.
Still, this is a case where it makes more sense to buy the mutual fund manager rather than the mutual fund.
Virtus Investment Partners (NASDAQ:VRTS) was spun off by The Phoenix Companies (NYSE:PNX) on Dec. 31, 2008. Phoenix shareholders received one share in Virtus for every 20 shares held in the parent. During the five-year period from 2002 to 2007, management restructured its business model to dramatically reduce its overhead and increase profitability. The result? Since early 2009, its stock is up more than 2,000%. Those who unloaded their shares in the parent and bought more of Virtus did very well indeed.
As of the end of March, Virtus had $51.2 billion in assets under management, 76% of which are retail mutual funds. In the first quarter, its long-term open-end mutual funds saw net flows increase 13.8%, or $3.56 billion, from the end of December, along with market appreciation of another $1.1 billion. As a result of this growth, its adjusted operating income in Q1 increased 57% year-over-year to $25.1 million. The first quarter was Virtus’ best quarter ever, growing equity and fixed-income fund sales by 79% and 49%, respectively.
Virtus’ product diversity has enabled it to gain market share, resulting in fatter margins. Even though it has had a strong four-year run, there appears to be plenty of growth ahead. This is my favorite of all four picks.
My final pick is Diamond Hill Capital Management (NASDAQ:DHIL), a registered investment adviser based in Columbus, Ohio, with $10.6 billion under management.
The 13-year-old firm has an investment philosophy that focuses on identifying the intrinsic value of a stock, then purchasing those that are trading at a discount to intrinsic value or whose intrinsic value is expected to grow. Once a stock represents 7% of a portfolio, it’s sold and the process is repeated. At the end of March, $6 billion of its assets under management were invested in its eight proprietary funds, including two long-short products. Long-term, most of its funds have outperformed their various benchmarks.
What makes Diamond Hill so intriguing is that it uses special dividends almost exclusively (no regular dividend and small share repurchase program) to reward shareholders. In the past five years, its annualized total return was 5.9%, 368 basis points greater than its asset manager peers. That return includes $46 in special dividends.
While there’s no guarantee that it will continue to pay out these dividends; its consistent if not spectacular revenue growth makes it very likely.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
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