|Shares Out. (in M):||169||P/E||18.7x||16.7x|
|Market Cap (in M):||50,722||P/FCF||0.0x||0.0x|
|Net Debt (in M):||1,056||EBIT||0||0|
Although this will show up as a recommendation to buy shares of BlackRock, more specifically I am recommending a pair trade of going long BlackRock and short IGM Financial. As such, this writeup should be read in conjunction with Carbone959’s excellent writeup (from November 14, 2013) recommending a short position in IGM.
The rationale is simple. IGM Financial is a crappy asset management firm. BlackRock is a very good asset management firm. Moreover, I believe there is a long term secular trend of low-cost, passively managed funds/ETFs taking share from high-cost, actively managed mutual funds. This secular trend will continue to serve as a tailwind for BlackRock while serving as a headwind for IGM Financial. Despite all this, BlackRock trades at almost the same P/E multiple as IGM Financial (19.2x for BLK vs 18.1x for IGM).
While I think BlackRock should trade at a much higher premium to IGM Financial, multiple compression/expansion isn’t necessary for this trade to be a winner. For reasons I elaborate below, BlackRock is likely to grow earnings at a faster clip than IGM Financial, making this trade profitable even if the relative multiples stay constant.
I’ll also point out that the short interest in IGM Financial is very low, and I easily found a borrow at a negligible rate.
BlackRock is the world’s largest publicly-traded asset management firm with $4.1 trillion of AUM as of 9/30/13. Being as big as they are, BlackRock’s product offering runs the gamut, including equities (52% of AUM), fixed income (30% of AUM), multi-asset (8% of AUM), alternatives (3% of AUM), and money market funds (6% of AUM).
What really differentiates BlackRock from other publicly-traded asset managers, however, is its exposure to passively managed strategies. Through its purchase of Barclays Global Investors in December 2009 for $15.2 billion, BlackRock added the iShares line of ETFs to its product offerings. Now, BlackRock’s passively managed products, including both iShares ETFs and institutional index products, account for 60% of total firm-wide AUM and 37% of revenue (through the first 9 months of 2009).
IGM Financial is Canada’s 2nd largest mutual fund manager, with CAD$126 billion of AUM as of 9/30/13. IGM focuses on retail investors reached through financial planners. IGM has two main brand names: Investors Group (~50% of AUM) and Mackenzie Investments (~50% of AUM). Investors Group mutual funds are distributed through a network of ~4500 Investors Group “consultants” who are IGM employees and are paid entirely on commission. Mackenzie funds are distributed mostly through third party financial planners.
Carbone959 does a much better job than I will in explaining why IGM is a crappy asset manager. To summarize however, IGM’s products are typically characterized by:
Of course, IGM Financial’s products have exhibited these characteristics for a long time, so it’s not as if the company is going away anytime soon. That said, these characteristics mean that IGM Financial struggles to grow AUM at the same rate as competitors like BlackRock. Since the end of 2009 (immediately after BlackRock acquired Barclays Global Investors), BlackRock has grown AUM by 22.4%:
Over the same time period, IGM has grown AUM by just 4.5%:
With subpar AUM growth, IGM grows earnings at a much slower pace. In 2010 (first full year of BlackRock ownership of BGI), BlackRock generated adjusted EPS of $10.94. That figure has since grown over 40% to $15.62 over the LTM period:
In contrast, IGM Financial generated CAD$2.89 in adjusted EPS in 2010. LTM EPS of CAD$2.97 has only grown 3% from the 2010 level:
Clearly, BlackRock’s business has performed better than IGM’s over the last few years. For the reasons I outline below, I think this trend is likely to persist:
BlackRock is a better asset gatherer than IGM Financial:
Below is a graph showing net subscription/redemption rate* for IGM Financial and BlackRock from 2010 through the most recent quarter. BlackRock’s net subscription rate has exceeded IGM’s in each of the last 6 quarters and in 11 of the last 15 quarters.
*As I’ve defined it here, net subscription/withdrawal rate is net client subscriptions or withdrawals in a quarter divided by the beginning AUM in the quarter.
The source of BlackRock’s asset gathering edge is sustainable:
If we break down BlackRock’s net subscription/redemption rates for its actively managed products versus its passively managed products (both institutional index funds and iShares ETFs), we see that passively managed offerings are driving BlackRock’s relative strength in asset gathering:
*For the chart above, I’ve excluded BlackRock’s advisory portfolio liquidation AUM (which is small anyway)
Because BlackRock’s asset gathering advantage is driven by its passively managed products, we don’t have to worry about a star manager leaving the firm, and we don’t have to worry about the firm’s portfolio managers going on a cold streak. I believe the trend of low-cost passively managed offerings taking share is secular one that should continue to consistently benefit BlackRock going forward.
Of course, the other takeaway from this chart is that BlackRock’s actively managed funds haven’t exactly been tearing the cover off the ball in terms of asset gathering. That said, BlackRock’s actively managed funds alone still have done better than IGM Financial’s in terms of net subscription/redemption rate over the last few years.
BlackRock is also likely to beat IGM Financial in fund performance:
If you go back and look at the two charts from earlier in this writeup that show total AUM growth for BlackRock and IGM over the last few years, you’ll see that market appreciation drove a 24% gain in BlackRock AUM since 12/31/09, whereas market appreciation only drove a 14% gain in IGM AUM over the same time period. In other words, recent history shows BlackRock’s funds outperforming IGM’s funds. But about going forward?
Because of BlackRock’s size and exposure to passively managed products, BlackRock’s fund performance, in aggregate, is likely to be pretty close to the market. As a smaller manager with actively managed products, IGM Financial’s fund performance is more likely to differ from the broader market. While they could conceivably go on a hot streak and start beating the market, I think it is more likely that their cold streak continues, based on the simple fact that their fee structure creates a high bar to jump over to simply keep pace with the market.
IGM’s fees have nowhere to go but down; BlackRock’s fees are already super low:
I referenced this earlier in the write-up, but to reiterate:
*Fees based on LTM period ending 9/30/13 and avg AUM over the period. Numerator includes distribution fees.
Amazingly, IGM’s fees over the LTM period are actually slightly lower than they used to be. In May of 2012, IGM announced changes to their pricing; management fees were lowered (by a total of between 5 and 40 bps) on two thirds of their mutual funds. This suggests that IGM is increasingly seeing pushback on its fees. Given that they still remain extremely high, I don’t think this pushback is going away.
Why do this as a pair trade?
I was very intrigued when I read Carbone959’s writeup of IGM, and I agree with him/her that there is a very compelling short case. After doing my own diligence however, I had two concerns about shorting IGM. My first concern is the lack of a specific catalyst. Carbone959 argues for a potential Canadian bear market as a catalyst, but I’m agnostic about the Canadian market going forward. My second concern is that while IGM’s P/E multiple (currently 18.1x) strikes me as too high, it’s not out of line with other asset managers and what IGM has traded at for much of the last decade.
By pairing the IGM short with a BlackRock long, I think these two concerns are largely mitigated. A decrease in IGM’s P/E multiple would certainly help the trade, but the trade is still likely to be profitable even without multiple compression, simply because BlackRock is likely to continue to grow earnings at a faster clip.
Because of its exposure to passively managed strategies and its reasonable valuation (especially compared to the asset manager universe), BlackRock is my favorite relative value in the sector and could be a good long in its own right. But without a corresponding short, I’m hesitant to buy an asset manager at a high teens P/E after a period that, due to outsized market appreciation, has been so favorable for asset manager earnings.
*Net market appreciation rate defined as growth in AUM attributable to market appreciation (or depreciation) divided by AUM at the beginning of the period.