The U.S. Capital Market sector is mature, competitive and subject to intense competition. This sector consists of 10,000 companies with annual revenue of $15 billion and assets under management (AUM) in excess of $13 trillion. While barriers to entry are low, it is difficult for competitors to build the scale and intangible assets necessary to compete in this business. The S&P Asset Management & Custody Banks Index increased 24.09% year to date. So let's take a look at two companies in this sector and see which one is doing better and thus stands as the best investment.
State Street Corporation (NYSE:STT) provides a range of products and services for institutional investors worldwide through its subsidiaries. Considering revenues reported in June 2013, the main products segments were Investment Servicing (66%), Investment Management (11%), and net interest revenue from the company's investment portfolio (23%). At that date, the company had more than $26 trillion of assets under custody and administration and $2 trillion of AUM.
The company has the scale (and scope) necessary to serve institutional clients, taking advantage from competitors that cannot match its profit margins. The company provides them with a variety of investment choices, but focuses on passive investments like index funds and ETF that are cost-effective investments. It´s ETF family held the second-place in market share of AUM in the U.S. at the end of 2012, and I expect this business will increase due to a shift from investors to these vehicles from mutual funds.
Non-U.S. Growth and Acquisitions to Drive Total Revenue
The firm plans to double non-U.S. revenues over a time horizon of five years as it had succeeded in expanding operations in the past. In June 2013, State Street's non-U.S. assets represented more than one fourth of assets under custody and administration. The company is taking advantage in less mature markets, such as Europe and the Asia/Pacific region, because they are part from the global market share growth strategy.
State Street is well positioned to grow via acquisitions. Great liquidity allowed the company to make several acquisitions in and out of the U.S in the last two years. In 2012, the company acquired the Hedge Fund Administration Unit of Goldman Sachs in order to gain field in the most lucrative corners of finance and strengthen its global presence. As a matter of fact, the company will be the largest hedge fund administrator in the world and we believe this is a growing sector and will exist as investors continue to want higher-than-average returns.
On the Same Path
Franklin Resources Inc. (NYSE:BEN) with more than $800 billion in AUM, and one third of them from clients residing outside the U.S., the company is one of the larger global asset managers.
A well product mix of diverse and innovative investment products provides it with an advantage over its competitors. A driver of the company is the well-known brands. Investment products are distributed under five distinct names: Franklin, Templeton, Mutual Series, Bissett and Fiduciary. Perhaps the only piece missing from the firm's product mix is a more developed ETF platform, but we don’t see much growth in this segment because there are several players well established, like BlackRock, Vanguard, Invesco and the actual State Street.
One third of its AUM are from investors domiciled outside the U.S. The company is also gaining market share with local products in Asia (India, Taiwan and Korea) and Latin America (Brazil, Chile and Mexico).
In 2010, Franklin took a 20% stake in Pelagos Capital Management, LLC. Recently, the company announced the completion of the purchase of the remaining 80% stake. Also, in November 2012, the company completed the acquisition of the controlling stake (69%) in K2 Advisors Holdings LLC, an independent fund of hedge funds solutions provider. The company has an agreement that it can purchase the remainder of K2. These acquisitions are promising when we think in worldwide expansions.
In terms of valuation, the next table shows two of the most used multiples:
|Company||Trailing P/E||Compared to Industry P/E Mean (=13.2)||Forward P/E|
|Franklin Resources Inc.||15||Premium||13.57|
Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: The return on equity.
|Company||ROE||ComparedtoIndustry Mean (=0.0)|
|Franklin Resources Inc.||21||Above|
State Street is attractive based on our view of its strong expansion outside the U.S. offering some protection against a downturn in the U.S. economy, and also the acquisitions efforts that have been made. On the other side, Franklin is one of the best administered asset manager, characterized by the similar strategies as the previous one and with high profitability.
It seems difficult to decide which one will perform better in the future. So let´s take a look in guru´s portfolio and see what they prefer. Hedge fund gurus like Jim Simons and Ray Dalio reduce position in State Street and added Franklin to their portfolios. Other gurus investing in the latter are Jeremy Grantham, Steven Cohen and Paul Tudor Jones. Therefore, I would advise fundamental investors should consider adding this stock to their portfolios as it seems to be an attractive option for investors.
Disclosure: Victor Selva holds no position in any stocks mentioned.