Franklin Resources: The Best Short In The Asset Management Space

The active fund management industry is under siege. After years of underperformance, investors are losing patience with active managers and as the cost of beta drops, assets are flooding to passive managers. The falling cost of beta isn’t the only reason why the active management industry is suffering. Low-cost robo-advisers and smart beta are replicating the services of traditional asset managers at a fraction of the cost.

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According to research from Morgan Stanley published earlier this year, the market leading passive fund provider Vanguard’s fees are as low as 13 bps per annum, compared to the average dollar-weighted expense ratio of mutual funds, which stands at 100bps. Meanwhile, the median fee rate for Smart Beta funds has fallen by 25 bps since 2012. The standard account fee for a Vanguard Robo account is only 30 bps, 70 bps less than the average mutual fund fee.

Most analysts expect the transition from active to passive management to accelerate going forward. According to research from Bank of America, published the beginning of this month, if the trend seen over the past few years continues for the next five years, passively managed equity assets could exceed actively managed equity assets by 2023 as a percentage of total industry assets under management.

Based on all of the above, it’s no surprise that short active asset managers is becoming a hot trade.

Franklin Resources: The Best Short In The Asset Management Space

Franklin Resources (BEN) has been pitched as the most compelling short in the asset management space at the MYST Advisors October 26 Bear’s Den Lunch.

Asset management industry trends are severely impacting Franklin’s growth and business model. According to the presenter who pitched Franklin as a short, the company has the highest average fees in the asset management space. Franklin’s average fee is 60 bps VS 45 bps to 55 bps for peers. These high fees are driving outflows, which are currently running at a rate of around 11% per annum. Franklin’s assets under management peaked at $921 billion in the fourth quarter of 2014 and have since declined to $732 billion.

In an attempt to try and stem outflows, Franklin’s management has hinted at possible acquisitions. But these acquisitions are unlikely to provide the kind of firepower the company needs to be able to return to growth. The Bear’s Den presenter speculated that if the company goes out and buys passive investment fund manager WisdomTree Investments (market cap. $1.3 billion compared to Franklin’s cash pile of $6 billion) the firm would be acquiring $40 billion of assets while outflows from the group’s legacy funds are running at an annualised rate of $80 billion.

Franklin may be the most attractive short according to the Bear’s Den presenter, but it’s not the most unattractive asset manager.

Research from Morgan Stanley shows it is, in fact, Waddell & Reed that is by far the most unattractive asset manager in the space, and the company is paying for it. Indeed, during the first half of 2016, Waddell reported asset outflows amounting to 31% assets under management, Franklin’s outflows during the first half were only 12% of assets under management (five asset managers reported larger outflows during the period).

For some reason, Waddell’s management appears to be totally out of touch with this trend. Morgan’s research shows that the company’s average dollar-weighted expense ratio stands at a staggering 1.4%, 33 bps higher than Franklin which has the second-highest dollar-weighted expense ratio in the industry.