Value & the eye of the beholder

In early May the once highly popular ASX-listed funds manager Janus Henderson (JHG) released a rather underwhelming March quarter financial performance report.

Among the key performance metrics that stood out was a -21% fall in earnings per share versus a year earlier, a sizable fall in operating margin to 34.4%, net funds outflows of -US$7.4bn, negative growth in performance fees, and an unchanged quarterly dividend of US36c. The latter is disappointing as the board is committed to a progressive dividend policy.

The day after the ASX release, the shares fell from above $35 to near $31, where they have remained since (well below most stockbroking analysts' price targets).

For Australian investors, whether they are shareholder in the company or not, it might be worthwhile to pay closer attention to what exactly is happening at the merger company (Janus and Henderson merged in 2017) because of the potential wider implications, including:

-global equity markets posting a strong V-shaped recovery year-to-date, while share prices for wealth managers in general have not wholeheartedly participated in the rally;

-Australian share market indices are now back near their post-GFC high, but earnings forecasts ex-resources continue to slide, as again witnessed when the banks reported this month, and with Janus Henderson's update equally triggering further reductions;

-the value-style of investing has not kept up with growth and the broader market for six consecutive years. Janus Henderson is a value investor itself and its own shares would have looked attractive to other value investors pre-quarterly update.

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As per always, there are various company-specific, idiosyncratic factors in play behind the disappointing March quarter update. Janus Henderson has lost the presence of former bond market demigod Bill Gross, while also suffering outflows because its team of emerging markets investment specialists has left or is in the process of leaving.

But even adjusting for these two - admittedly major - setbacks, one shouldn't lose sight that, underneath the surface, the challenge is 'on' and this very much resembles the industry as a whole, globally. The March quarter report proudly highlights the fund manager improved its overall investment performance with now 69% of all assets under management (AUM) outperforming the benchmark on a three-year horizon.

While this marked a noticeable improvement from the 61% comparable number as at December 31, investors are being reminded back in 2017 the same Janus Henderson was able to advertise close to 90% of its assets were outperforming benchmarks on a 5-year comparison, while for a 3-year horizon the number peaked above 75% in Q3 2017.

Equally important is that the weaker, underperforming strategies, including fixed interest (bonds) and Intech, are seemingly being punished harshly, with sizable funds shifting elsewhere. Look closer, and a picture emerges of funds steadily flowing elsewhere.

As shown in the graphic flash back below (source: UBS), Janus Henderson has only managed to report net inflows in one quarter since the start of calendar 2017. Mind you, all this occurred during a period when equities mostly performed positively (as did bonds). Imagine the shock impact of a net -US$7bn outflow when share markets go through a prolonged correction, or even a flattish, moribund period.

Not making matters any rosier for the asset manager, analysts already spotted sufficient indications more funds are ready to abandon the Janus Henderson portfolio in quarters to come, including on the back of the EM team leaving. In fact, analysts at both Citi and Macquarie suggest net outflows might remain a feature for the asset manager throughout each of the remaining three quarters of 2019.

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For those investors, and analysts, looking for a potential silver lining there are plenty to choose from. Post the latest public flogging, Janus Henderson shares are trading at a considerable discount versus peers, estimated by some analysts at no less than -42%. FNArena's Stock Analysis (see website) shows analysts' price targets, with exception of Credit Suisse's, sit at double-digit percentages above the present share price.

The prospective dividend yield, at current AUD/USD and twelve months out, has risen to a juicy 6.8% while the share price should also find support from the company's running buyback program. To date, only US$31m worth of shares have been bought back when the ultimate target is to buy back US$200m in 2019.

The company is keeping a tight lid on operational costs. While -US$7.4bn and -US$8.4bn in net outflows during the past two quarters are sizable losses, the company in total manages some US$350bn. Even if net outflows continue to be of similar size in the quarters ahead (which seems rather unlikely, but not entirely impossible), it will not send the company broke.

At some point, one would have to assume, things should stabilise and the asset manager might even achieve further improvement in performance and performance fees again.

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The big question that remains unanswered, however, is how much of the pain that is descending on the industry this year, also impacting peers including AMP (ASX:AMP), Pendal Group (ASX:PDL) and Perpetual (ASX:PPT), is simply of a short-term, fleeting nature, and how much is indicative of rising pressure when the trend remains firmly in favour of passive investment instruments that offer market conform returns at (much) lower cost?

The uncomfortable truth, for all active managers, is that investment funds around the world are increasingly being directed towards lower cost, passive instruments. At the same time, the number of active managers around the world is still increasing as many continue to believe they can outperform indices and their peers, and attract sufficient funds to prove it.

At the same time, many asset managers with a commendable track record going back to inception a long way back, are finding it increasingly harder to consistently outperform their benchmark, and justify their management fee. Here is a simple test every investor can undertake at their own leisure: visit the websites of active managers and look up monthly performance updates.

What you are likely to find is that most performances on a 3- and 5-year horizon remain well below historical track records, and fail to beat indices and benchmarks over that period.

One of the key reasons for this is, of course, the fact that so many seemingly "cheap" stocks, trading below intrinsic value, have proven to be mere value-traps rather than bargain entry points for value seeking investors. And Janus Henderson shares would be among those with the shares having peaked above $62 in November 2015, only to steadily de-rate towards $31-something today.

Herein lies a stern lesson for value investors who cannot look beyond the attraction of a beaten down share price: real future value creation can only materialise when the company in question is able to produce a sustainable turnaround. But what are the odds of that happening when the sector itself goes through transformational turmoil?

I don't know how exactly this sector might look like in, say, five or ten years' time, but my best guess is more money goes towards passive instruments, while the number of active managers needs to shrink, and margins will be under pressure, while human staff have to fend off robots, quants and artificial intelligence.

Put all these factors in the mix, and there is a case to be made that today's active fund managers are in the same boat as bricks and mortar retailers, and landlords of bricks and mortar retailers, as well as numerous other sectors that are challenged for future relevance, if not ultimate survival.

On my observation, many stocks in these sectors have experienced numerous rallies in years past, but share prices have time and again returned to lower price levels, well off from prior peaks and historical averages.

Maybe this is the real message today's investors should heed and incorporate in their strategies?