Zero-fee ETFs and the decline of active investing – the phenomenon arising from the so-called "Race to Zero" across the investment management industry - is a prominent example of the notion that what benefits the customer does not always benefit the business owner. The trend is entirely rational, being all about corrections to the "no-moat" mismatch between cost and value for clients. After all, most stock-picking fund managers cannot outperform the market index consistently.
Despite the industry-wide headwind, we think of the asset management business model as being attractive for its high scalability, low CapEx requirement, recurring nature of sales, cash richness and potential to hedge inflation. However, investors may have to dig deep into niches to find players that can (hopefully) defy the "Race to Zero" and keep their doors open. Below are three picks from our research.
Tatton Asset Management
Tatton Asset Management (LSE:TAM, Financial) is the leading provider of on-platform discretionary fund management services for independent financial advisors in the UK. The investment approach at Tatton primarily involves model portfolio, asset allocation and rebalancing, with the goal to achieve returns commensurate with the risk profile of clients. That means that the company is in a totally different space from many of those asset managers that fight for alpha. In our view, this gives it a much more favorable chance of winning over the long run.
Tatton Asset Management leverages its substantial scale and a niche focus to charge the lowest fee among all providers in the UK and therefore compete favorably. The business currently generates over a 50% return on invested capital, earns a 39% free cash flow margin and consumes less than 3% of sales to fund CapEx.
Federated Hemers
Pennsylvania-based Federated Hermes (FHI, Financial) is an asset manager specialized in the money market and responsible investing. The company only has 12% of its assets under management in equities – the class that is most disrupt-able amid "Race to Zero." The main assets are mostly in the money market, fixed income and alternative/private markets. Over recent years, the company has also expanded into the responsible investing domain, where we see tailwind overweighs headwind.
Today, Federated Hermes is a reputed top-tier provider of both liquidity solutions as well as ESG advisory services. The business currently generates over a 23% return on invested capital, earns a 24% free cash flow margin and consumes a little over 1% of sales to fund CapEx.
City of London Investment Group
UK-based City of London Investment Group (LSE:CLIG, Financial) is an institutional asset manager focused on closed-end fund investments. The company deals with a rare asset class that the market efficiency hypothesis no longer applies to. Its principal investment strategy is to benefit from the narrowing discount on closed-end funds to net asset value through corporate actions like open-ended tender offers and liquidation, where the company employs its proprietary expertise.
City of London Investment Group has a decades-long track record of outstanding performance in the closed-end fund niche, which is difficult for peers and new entrants to match. The business currently generates a 43% return on invested capital, earns a 31% free cash flow margin and consumes less than 2% of revenue to fund its CapEx.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of City of London Investment Group and Tatton Asset Management.
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