Advisor Intel: Should Your Clients Be Investing in Asset Managers?

Asset management stocks are still cheaper than they were a year ago, yet the recent rally suggests a need for caution when buying the biggest names and underperforming stocks are not likely to improve soon.

According to Keefe, Bruyette and Woods, for investors interested in cash, it’s a good idea to look into the chance of share buybacks. According to a 2007 study in The Journal of Finance, the “net payout ratio,” may also predict future equity returns better than the dividend yield. The ratio represents the percent of each invested dollar that a company is returning to shareholder.

The category as a whole should have a good year, especially those companies that manage alternative investments, asset-allocation, total return or dividend-bearing stocks. KBW forecasts an average 7.6% point-to-point increase in assets under management for this year, a 7.5% increase in 2011, and a 8.3% increase in 2012.

But asset management stocks are often overbid coming out of recessions. “While we see value in the group, the recent sharp rally in many traditional asset management names leaves us somewhat cautious over the near term as we’ve witnessed time and again investors bidding up asset management stocks in advance of an expected improvement in flows or margins, only to be left standing at the altar when it either doesn’t materialize, or if the anticipated impact is more modest than some investors may have expected,” Larry Hedden and Jacob Troutman at KBW wrote in their latest outlook.

On the other hand, asset-management stocks trading at value-like levels, such as AllianceBernstein and Artio, have had consistent net outlows and their performance as stock managers has been poor.

Here’s where checking net payout ratios may make a difference. A cautionary note: unlike dividends, which tend to remain stable, share buybacks vary from one year to the next.

To calculate the ratio, add together the cash the company spends on dividends and share buybacks.  Then subtract its share issuances, and divide by the company's current market cap.

In the asset management industry, Legg Mason, Blackstone Group, and AllianceBernstein all show a commitment to returning cash to shareholders, with Legg Mason especially inclined to buy-backs. 

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