Like many things in life, size matters, and in the asset management industry this paradigm is no different. A large asset management company is able to enjoy substantial incremental operating leverage. (Operating leverage is a situation where revenue increases more than costs and hence operating margins improve) A lot of times, the incremental cost of managing $10 billion in client assets and $5 billion is quite minimal. The industry in the U.S. is made up of one giant monolith in BlackRock, with a handful of other firms that also have greater than 5% market share of the industry’s assets.
The market leader in client assets is clearly BlackRock (BLK) with over $3.5 trillion in client assets which totals 45% of the asset management industry. BlackRock is a market leader in many categories but is best known for its iShares exchange traded funds (ETF) platform which makes up 25% of its assets-under-management. BlackRock also has a leading mutual fund franchise and substantial products in Alternatives including real estate and hedge fund offerings.
The next 5 biggest asset managers are relatively similar in size with client assets in the range of $400-$700 billion. These managers include Franklin Resources (BEN), which is best known for its Global Bond product and its leading Mutual Series family of funds and also T Rowe Price (TROW), which historically has had the best overall performance in the mutual fund industry with its specialty of growth and value stock investing.
Differing asset management strategies
While strategies can differ quite substantially in the industry, a fundamental method for valuing an asset management business is to look at its market capitalization to client assets-under-management[3. Dubbed market cap to AUM this ratio looks at the market cap of the asset manager divided by its client assets-under-management]. The industry average as relayed above is 2.4% which means that the average valuation in the market of an asset management company is 2.4% of the client assets that it manages.
Larger companies tend to trade at a smaller market cap to AUM ratio because with a bigger client asset base it is harder to grow versus a smaller up and coming manager which can quickly expand its client asset base with a more meaningful impact on its results. In addition, asset managers that oversee more equity portfolios versus fixed income portfolios tend to trade at a higher ratio because equity assets have a higher fee schedule than fixed income.
Market cap matters
This is illustrated by Waddell and Reed’s (WDR) market cap to AUM of 4.0% with more equity assets as a percentage of total versus a company like Legg Mason (LM) which is comprised of more fixed income assets and hence results in a 0.6% market cap to AUM (we also believe LM’s multiple is depressed as the company is under earning currently).
Market cap to AUM is another ratio that investors should be aware of and it is a benchmarking tool for any group of companies with fee generating client assets under management.