The stock price and valuation of an investment firm is driven by many factors. The key drivers are the assets under management, fee structure, investment performance, growth prospects, competitive positioning, profitability, dividend policy and macroeconomic conditions. Investment firms, also known as asset management or fund management companies, earn fees by managing assets on behalf of clients. The level and growth rate of assets under management is crucial as it determines the fee revenue. Fee rates charged to clients are also important. Superior investment performance can attract assets while subpar performance results in outflows. The ability to grow assets via new product offerings and distribution reach is critical for valuation. Profit margins, return on equity and dividends impact shareholder returns. The stock price often trades at a premium to book value given the high return on equity. However, during bear markets, investment firm stocks get punished due to expected declines in assets under management.
Assets under management drive revenues and are key valuation metric
The assets under management (AUM) is perhaps the single most important driver of an investment firm’s stock price. The level of AUM determines the management fee revenue earned by the firm. Growth in AUM also drives growth in revenues. Fund management fees are charged as a percentage of AUM, typically in the 1-2% range annually. The fee schedule varies by asset class and differs across retail and institutional clients. Larger clients are able to negotiate lower fees. The mix of assets across asset classes and client types impacts the overall average fee rate. Equity funds typically have higher fees than fixed income or money market funds. Retail investors pay more than large institutional clients. AUM size gives an investment firm scale and operating leverage. Larger asset managers have competitive advantages in distribution, product offering and operations. The market rewards larger asset managers with higher price-to-earnings multiples. Hence, AUM growth via net inflows and positive investment returns is enormously important for investment firms.
Superior investment performance attracts assets
Delivering strong investment performance for clients is vital for investment firms. Funds that consistently outperform their benchmarks and peer groups tend to attract the most asset inflows over time. Retail investors in particular chase recent performance. Superior performers see net inflows while poor performers suffer outflows. Fund performance impacts an investment firm’s reputation and aids distribution efforts. Firms that have a greater percentage of funds outperforming category benchmarks over 3-5 year periods tend to grow AUM at a faster rate. However, performance tends to mean revert over longer periods. Having a broad range of capabilities and diverse product offering gives a firm the flexibility to rotate asset flows towards better performing strategies. Offering both active and passive investment approaches also helps win AUM.
Growth strategy and competitive position affects valuation
An investment firm’s strategy for growth and competitive positioning impacts its valuation multiple. Firms focused on rapidly growing AUM are viewed more favorably than slow-growth managers. Market share gains suggest strong distribution capabilities and increasing scale. Acquiring competitor firms or new capabilities via mergers can boost growth prospects. Expanding internationally and offering new product lines also helps drive AUM higher. However, growth via acquisitions comes with execution risks that must be managed carefully. Leveraging technology and big data for security selection can be a competitive advantage. Investment firms with high switching costs, loyal clients and a niche focus may warrant higher multiples. Those facing pricing pressure, fee compression and lackluster investment performance will struggle to grow AUM.
Profitability and shareholder returns impact valuations
The profit margins and returns on equity of investment firms affects their share prices. Fund management is a high margin, high return on equity business due to the operating leverage from AUM. Net profit margins range from 25-40% while ROE is typically above 20%. Investment firms with margins and ROE above industry peers warrant higher valuation multiples. However, if margins are compressed due to fee reductions, expenses rising faster than revenues or poor cost controls, multiples contract quickly. Investment firms are required to distribute essentially all net income to shareholders as dividends. Dividend payout ratios among asset managers approach 100%. Growing dividends over time rewards shareholders. Higher dividend yields may indicate concerns about slower growth prospects. Share repurchases also return cash to shareholders. Conservative balance sheets with low leverage provide flexibility to deploy capital.
Macroeconomy and market cycles influence investment firm valuations
The macroeconomic environment and financial market cycles have an enormous influence on investment management firms’ stock prices. During strong bull markets when asset prices are rising, investment firms benefit from higher AUM as a result of market appreciation and net inflows. However, bear markets severely depress AUM which directly impacts revenues. Even if outflows are minimized, mark-to-market declines in existing fund assets quickly hits the top line. This was clearly evidenced in 2008-09. Lower interest rates also pressure money market and fixed income returns over time. On the other hand, periods of strong economic growth provide tailwinds for equity fund inflows. Individual investor confidence and activity levels also drive fund flows and asset manager valuations.
An investment firm’s stock price and valuation is driven by assets under management, fee rates, investment performance, growth strategy, profitability, dividends and macroeconomic factors. Growing AUM is paramount but not easy during volatile markets. Delivering alpha for clients builds reputation. Scale and competitive advantages warrant higher multiples. Profitability metrics directly impact shareholder returns. Periods of elevated market volatility present headwinds for investment managers.