Many asset managers are in a rough spot these days.
Low-cost passive approaches have been taking market share from high-cost active strategies for a long time now, and that trend has no signs of stopping. This has put cost pressure on asset manager fees, so that rather than increase prices in line with inflation, many fees related to financial services have been on the decline. Brokerage fees are down, ETF expense ratios are down, active fund fees are down, etc.
I have been very selective with the asset managers I invest in. I have a preference for alternative asset managers like Brookfield Asset Management and Sprott Inc, and am also long Lazard and BlackRock.
These companies have been gaining assets under management (AUM) because they do one of two things. First, some of them cater to passive investors, like BlackRock via their iShares ETF brand. Second, some of them do niche things that still outperform passive indices and cannot be replaced by passive indices, like Brookfield with their real operating assets (infrastructure, real estate, renewable energy, and private equity).
Source: Lazard 1Q2019 Presentation
Asset managers that are in the middle are being squeezed. The “middle” in this context refers to asset managers that primarily invest in active stock-picking or bond-picking strategies that don’t outperform. If they just invest in stocks, for example, they better outperform the S&P 500 or else who will give them their money?
A Look at Invesco (IVZ)
Invesco is the 13th largest asset manager in the world and offers a variety of products for passive and active investors.
Source: Invesco 1Q2019 Presentation
They operate the popular QQQ ETF and a variety of factor-based ETF strategies.
I particularly like their lead in equal-weight strategies. Their equal weight S&P 500 ETF (ticker: RSP) has significantly outperformed the standard SPY ETF since inception:
They also have a variety of sector-specific equal weight strategies, and most of them have outperformed their market weight SPDR sector equivalents.
Truly, the sheer number of sector-specific or factor-specific moderate/low cost ETFs offered by Invesco is like a playground for hands-on investors that want to express convictions in certain industries, factors, or asset classes without having a middle-man actively pick stocks for them.
Invesco is Cheap
Invesco has been skirting around the middle for a while, but is very cheap and may be rising out of the middle. They have many great passive and factor (“smart beta”) ETFs while also having a variety of active strategies. Their active strategies generally fall within the problematic middle, while their passive strategies are benefiting from the shift towards passive products while being oppressed by fee suppression.
Additionally, Invesco has long been in the middle in terms of how large their asset base is. Asset management is an industry that benefits from economies of scale; larger firms enjoy a lot of cost synergies and can keep fees low. Smaller firms must excel in niche higher-fee products or they are worthless. Invesco is not as big as some of the giants like Vanguard and BlackRock, but is still one of the larger asset managers, which puts them in a problematic middle area.
Fortunately, Invesco recently acquired OppenheimerFunds, which increased their AUM to over $1 trillion and gave them $475 million in annual permanent cost synergies. And these aren’t buzzword synergies, these are true reductions/combinations in personnel, marketing, and offices as they consolidate their platform and offerings.
Source: Invesco 1Q2019 Presentation
For my buy-and-hold investments that I keep for the long run, I look for companies that generate high returns on invested capital. Unfortunately, due to the fee suppression that most asset managers are facing, it’s not a high return industry. Industry titan BlackRock generates mediocre ROIC of about 10% while Invesco is around 5-6%.
However, Invesco should be able to push up to 7-8% over time as it realizes cost synergies and secures its place as one of the world’s top asset managers. It may be not be a great buy-and-forget holding for the long run, but whenever it gets cheap enough, it becomes a deep value intermediate-term investment opportunity.
Invesco currently pays a dividend yield over 6% with a safe payout ratio, and is trading well below its 5-year average valuation ratios:
At this price of under $20/share, Invesco is slightly undervalued by the Graham formula even if the company achieves 0% growth over the next 5+ years. My StockDelver model also shows mild undervaluation for 10% annual returns even with no growth:
However, despite the fact that today’s price is reasonably-valued even without growth, I would wait for a pullback before considering initiating a position. Asset managers like Invesco make most of their revenue from fees as a percentage of their AUM, so if there is a stock sell-off or recession, Invesco’s AUM and fee revenue would decline. This would likely trigger a buying opportunity, in my opinion.