Finding the Best American Asset Manager
Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since the recession hit the U.S. economy, rising unemployment has been a serious problem, and interest rates have remained incredibly low. This changed the focus of people towards stocks that could provide regular income to run their households. Dividend giving companies have been the main focus for these investors. Also, retired individuals and older people in the U.S. also focus on regular income providing companies rather than growth companies, to meet their day to day expenses.
The economic recovery is increasing the asset management industry’s profitability, but there are challenges as well. The assets under management will increase in the coming years, but only firms that change their policies according to the changing environment will be able to get the benefit.
There has been a slight recovery in the industry during the last year. Disturbed financial markets, new laws, more demanding investors and increasing competition for talent are making profitable growth difficult to achieve.
The financial crisis and its aftereffects have highlighted the risks of asset managers. The increased linkage between credit, market, liquidity and valuation risks stress the need for more adaptive approaches to investment risk management. As a result, managers are beginning to follow an enterprise wide approach to risk.
Lazard (NYSE: LAZ), Kohlberg Kravis Roberts (NYSE: KKR) and American Capital (NASDAQ: ACAS) are the three main companies in the asset management industry that have charged higher fee yield despite the recession, based on their quality of service provided to investors. On the other hand, Legg Mason (NYSE: LM), has been the most popular company and has the highest assets under management.
I have picked up the four dividend paying companies above to analyze in this report from an investment perspective. The report focuses on choosing the company with most favorable returns in the coming years.
Financial performance analysis
Source: Company Financials
In spite of the pressure on asset managers to reduce the fees charged from the large institutional investors, Lazard was able to charge a high fee yield of 113 bps. The merger and acquisition advisory segment contributed the major portion of fee income as the company specializes in crafting solutions to the complex financial and strategic challenges of a diverse set of clients across the world. The value of Trans-Atlantic merger and acquisitions transactions announced in FY12 increased significantly by 24%. The American Capital and and Kohlberg were next to report healthy fee yields.
Legg Mason has been trying to earn a higher absolute fee income through managing higher volume of assets. The company has the highest assets under management i.e. $665 billion. Moreover, the company is trying to work on its negative operating and net margin by investing a major portion of its investment portfolio in fixed income i.e. 55% to get promised returns. However, the problem lies in the fact that Legg Mason has 21% of its assets invested in liquid funds, which are likely to produce a very small return on the huge amount allocated to this area.
Although Lazard has greater assets under management, yet Kohlberg and American Capital have performed better by effectively managing their fewer assets. Lazard’s compensation and benefits expense in 2012 increased by 16%, compared to 2011. This is because of the $22 million first quarter 2012 charge due to staff reductions and a fourth quarter 2012 charge of $100 million related to the cost saving initiatives. Also, Lazard has invested a huge amount of 83% of its investment portfolio in equities. The volatility associated with equity investment makes the company’s returns highly volatile as well.
American Capital is the only company that has been able to gain the advantage of earning higher fee yield in the form of higher net income, as shown by the graph. Though the company has the lowest assets under management, it has managed these fewer resources very well. The company reported a very high operating margin of 61.46% and was also reflected in its EPS, unlike Kohlberg. Revenues increased due to interest income on structured products investments by 20% for FY12 over the comparable period in FY11, owing to the increase in cash flows on collaterized loan obligation investments. Also, dividend income on private finance portfolio investments increased by 52%, mainly because of an improvement in preferred equity investments. As a result, the monthly weighted average effective dividend yield on equity investments was 7.6% for FY12, representing a 290 basis point increase from the prior year.
American Capital had 58.8% of its assets invested in equities of middle market companies, followed by 34.6% in senior and mezzanine debt, with attractive current yields and price appreciaion. The remainder 6.6% is invested in structured products. The company has effectively maintained a balance between investing in high yield risky stocks and low return givers with minimum risk.
Sooner, many investors will shift funds to American Capital to benefit from the efficient fund management and earn a portion of higher returns that the company has displayed. Thus, based on the potential that American Capital holds, I would recommend buying this stock to benefit from the price return in the next few years.
However, for investors who prefer a steady rising flow of income, Kohlberg is the stock to invest in as the company has displayed a history of rising dividends. Though Legg Mason also gives regular dividends, in the last five years the company’s dividends have fallen quite an extent. Lazard is also not a recommended investment for income seekers, as its dividend yield is quite lower than Kohlberg.
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Awais Iqbal has no position in any stocks mentioned. The Motley Fool owns shares of LAZARD Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!