JONATHAN CASTELEYN, CFA JOSHUA STEINER, CFA T. ROWE PRICE (TROW) PADDLING UPSTREAM BEST IDEAS SHORT. March 2016

Transcription

1 JONATHAN CASTELEYN, CFA JOSHUA STEINER, CFA T. ROWE PRICE (TROW) PADDLING UPSTREAM BEST IDEAS SHORT March 2016

2 DISCLAIMER DISCLAIMER Hedgeye Risk Management is a registered investment advisor, registered with the State of Connecticut. Hedgeye Risk Management is not a broker dealer and does not provide investment advice for individuals. This research does not constitute an offer to sell, or a solicitation of an offer to buy any security. This research is presented without regard to individual investment preferences or risk parameters; it is general information and does not constitute specific investment advice. This presentation is based on information from sources believed to be reliable. Hedgeye Risk Management is not responsible for errors, inaccuracies or omissions of information. The opinions and conclusions contained in this report are those of Hedgeye Risk Management, and are intended solely for the use of Hedgeye Risk Management s clients and subscribers. In reaching these opinions and conclusions, Hedgeye Risk Management and its employees have relied upon research conducted by Hedgeye Risk Management s employees, which is based upon sources considered credible and reliable within the industry. Hedgeye Risk Management is not responsible for the validity or authenticity of the information upon which it has relied. TERMS OF USE This report is intended solely for the use of its recipient. Re-distribution or republication of this report and its contents are prohibited. For more details please refer to the appropriate sections of the Hedgeye Services Agreement and the Terms of Use at HEDGEYE 2

3 PLEASE SUBMIT QUESTIONS* TO *ANSWERED AT THE END OF THE CALL

4 TROW OUR HISTORY Shares of TROW have been on our Best Ideas Short list since August 2014 when the stock was over $80. Although shares dipped below $65, we continue to see risk that warrants a Short call. DATA SOURCE: HEDGEYE ESTIMATES HEDGEYE 4

5 TROW: INTRO WHO IS T. ROWE PRICE? Founded in 1937 TROW is a leading stock fund manager with headquarters in Baltimore Maryland. The company employs 5,900 associates. DATA SOURCE: COMPANY DATA, BLOOMBERG, HEDGEYE ESTIMATES HEDGEYE 5

6 TROW: INTRO WHO IS T. ROWE PRICE? Founded in 1937 TROW is a leading global, growth stock manager with headquarters in Baltimore Maryland. The company employs 5,900 associates. DATA SOURCE: COMPANY DATA, BLOOMBERG, HEDGEYE ESTIMATES HEDGEYE 6

7 THESIS: A BLUE CHIP COMPANY WITH BLUE TRENDS 1 2 ACTIVE ONLY IN AN INCREASINGLY PASSIVE WORLD Passive products have only just now cracked low teens in market share and with tailwinds including the DOL Fiduciary rule, continue to threaten the active industry. Large Cap strategies are most at risk and TROW maintains the biggest exposure there. TARGET DATE NOT A BULLSEYE ANYMORE TROW s last bastion of growth is the Target Date (TD) retirement channel but ETFs have also made sustainable inroads there. What was once mid teens growth for the firm in TD is threatening to dip into single digits which will mean flat or negative growth for the overall franchise. Pricing trends continue to soften for the industry in TD which means overtime profitability is coming out too. 3 DATA SOURCE: HEDGEYE ESTIMATES TOP OF CYCLE WITH DOUBLE LEVERAGE TROW is operating at peak historical margins with market appreciation generating all the net new assets at the firm. This is a dangerous gambit for investors with the firm rolling to lower margins and relying 100% on continued gains in equities to raise overall AUM levels. With no meaningful fixed income business or Passive suite to soften any downturn, the firm s results have unappreciated negative leverage. HEDGEYE 7

8 THE ETF ASTEROID IS SPEEDING UP THE DOMINANCE OF INDEXING IS ACCELERATING DATA SOURCE: BLACKROCK HEDGEYE 8

9 ETFS MORE ROOM TO DISRUPT While ETFs seem to be the most trite acronym in finance their penetration rate is still just 13.6% against the antiquated mutual fund vehicle which holds 84% of long term assets. DATA SOURCE: BOB LITAN PRESENTATION TO HEDGEYE RISK MANAGEMENT HEDGEYE 9

10 ETFS MORE ROOM TO DISRUPT Equity Equity ETFs ETFs $1,300 $1,347 ETF'S ARE GAINING SHARE Equity Mutual Funds ($390) The ETF category is gaining significant market share relative to the traditional mutual fund category. DATA SOURCE: COMPANY DATA, WISDOMTREE, BLOOMBERG HEDGEYE 10

11 ETFS MORE ROOM TO DISRUPT ETF'S ARE GAINING SHARE The ETF category is gaining significant market share relative to the traditional mutual fund category. DATA SOURCE: ICI, BLOOMBERG HEDGEYE 11

12 ETFS MORE ROOM TO DISRUPT Of the over $879 billion that has been pulled from all U.S. equity mutual funds since 2007, over 55% has been from Large Cap strategies, the biggest single component of any single ICI equity category DATA SOURCE: ICI, BLOOMBERG HEDGEYE 12

13 ETFS MORE ROOM TO DISRUPT CONVERSELY ETF GROWTH HAS PREDOMINANTLY BEEN IN LARGE CAP Conversely of the $1.3 trillion that has flowed into ETFs since 2007, 67% or over $904 billion has been in discrete Large Cap equity strategies. DATA SOURCE: MORNINGSTAR DIRECT, BLOOMBERG HEDGEYE 13

14 ETFS MORE ROOM TO DISRUPT Of the Top 10 grossing ETFs since 2007, 7 of the 10 are specifically Large Cap strategies including the biggest products from StateStreet, Vanguard, and BlackRock. DATA SOURCE: MORNINGSTAR DIRECT, BLOOMBERG HEDGEYE 14

15 ETFS MORE ROOM TO DISRUPT Of the big six public asset managers, TROW has the biggest percentage of Large Cap Strategies within all its mutual funds at ~29%. The average of All Morningstar Funds in Large Cap is 17%. DATA SOURCE: MORNINGSTAR DIRECT, BLOOMBERG HEDGEYE 15

16 ETFS MORE ROOM TO DISRUPT Monthly organic growth in all non Target date funds has been in a consistent downward trajectory since 2007 and is now barely above zero. The next move in our view is to go negative. DATA SOURCE: MORNINGSTAR DIRECT, BLOOMBERG HEDGEYE 16

17 ETFS MORE ROOM TO DISRUPT The entire shift to ETFs from mutual funds is more problematic for TROW as it has closed 23% of its fund franchise to new investors with $112 billion shut off to protect performance and for target date use DATA SOURCE: COMPANY DATA HEDGEYE 17

18 DOL FIDUCIARY RULE IS ONEROUS The source of the forthcoming DOL Fiduciary Rule is that a simple study of 3 rd party distributed retirement products underperformed other funds by >100 bps so the rule focuses on governing those products DATA SOURCE: BOB LITAN PRESENTATION TO HEDGEYE RISK MANAGEMENT HEDGEYE 18

19 DOL FIDUCIARY RULE IS ONEROUS The Fiduciary Rule as stated now assigns investors private right of action for violations of the rule or class action lawsuits against distributors for recommending products that underperform DATA SOURCE: BOB LITAN PRESENTATION TO HEDGEYE RISK MANAGEMENT HEDGEYE 19

20 DOL FIDUCIARY RULE IS ONEROUS Thus index funds will get a boost as by definition they are not active or conflicted advice and can t underperform the market so advisors will be absolved from liability if they use them. DATA SOURCE: BOB LITAN PRESENTATION TO HEDGEYE RISK MANAGEMENT HEDGEYE 20

21 DOL FIDUCIARY RULE IS ONEROUS And active managed fund providers are on top of the list of potential losers as Fiduciaries will be less likely to use active products that have the potential to underperform and create liability. DATA SOURCE: BOB LITAN PRESENTATION TO HEDGEYE RISK MANAGEMENT HEDGEYE 21

22 DOL FIDUCIARY RULE IS ONEROUS An estimate of total retirement related AUM, which the DOL Fiduciary Rule is targeting, puts TROW over 25%, over 3 times that of the industry average of 8.3%. Industry Average DATA SOURCE: MORNINGSTAR DIRECT HEDGEYE 22

23 DOL FIDUCIARY RULE IS ONEROUS The Fiduciary Rule also all but insures that record keeping and AUA costs will go up for IRA providers and TROW is a Top 15 provider with just over 10% of its AUM in IRAs. DATA SOURCE: CERULLI ASSOCIATES HEDGEYE 23

24 DOL FIDUCIARY RULE IS ONEROUS While nowhere near the top of payers to the brokerage community, over 60% of TROW funds do pay for 3 rd party distribution via the 12b-1 fee. DATA SOURCE: CERULLI ASSOCIATES HEDGEYE 24

25 DOL FIDUCIARY RULE IS ONEROUS RECENT 10-K DISCLOSURE TROW s most recent annual filing outlined that 45% of its AUM is distributed by 3 rd party intermediaries DATA SOURCE: T. ROWE PRICE HEDGEYE 25

26 TARGET DATE NO BULLSEYE ANYMORE HEDGEYE 26

27 TARGET DATE HAS CROSSED $700 B Total Target Date AUM has crossed $700 billion. Organic growth which was break away at well over 30% before 2008 has now slowed under double digits to just +8% as of last count. DATA SOURCE: MORNINGSTAR HEDGEYE 27

28 A 3 HORSE RACE IN TD FUNDS The low cost providers Vanguard and Fidelity are interchangeable at the top of the table with TROW a solid third with 17% share. No other firm has more than 5% market share. DATA SOURCE: MORNINGSTAR HEDGEYE 28

29 A 3 HORSE RACE IN TD FUNDS And Recordkept Assets helps maintain a barrier to entry and also protect margins with the delivery of target date retirement products. DATA SOURCE: CERULLI ASSOCIATES HEDGEYE 29

30 BUT OVERALL DC IS NOW IN OUTFLOW DATA SOURCE: DEPARTMENT OF LABOR, CERULLI ASSOCIATES HEDGEYE 30

31 TARGET DATE STARTING RUN OFF The oldest members of the baby boomers turned 65 in 2011 which has started a run off in the formerly growth only target date fund industry. DATA SOURCE: MORNINGSTAR HEDGEYE 31

32 TARGET DATE STARTING RUN OFF Which is showing up in TROW s franchise as well as most older series from the 2015 vintage backwards showing decay now DATA SOURCE: MORNINGSTAR, T ROWE PRICE HEDGEYE 32

33 TARGET DATE STARTING RUN OFF This puts annualized redemptions rates between - 4.8% and -21.8% as the boomers start to sell off their financial assets to turn into cash to spend in retirement DATA SOURCE: MORNINGSTAR, T ROWE PRICE HEDGEYE 33

34 PASSIVES GAINING IN TD USAGE In 2005 actively managed target date was 90% of total TD assets. However of latest count they are only 67% with passive TD funds using ETFs now 33%. Furthermore new fund flow is now 50/50. DATA SOURCE: MORNINGSTAR HEDGEYE 34

35 PASSIVES GAINING IN TD USAGE Of the manufacturers that produce both active and passive TD funds, Active products are mainly in decay with TD funds that rotate with passive index funds growing AUM DATA SOURCE: MORNINGSTAR HEDGEYE 35

36 PASSIVES GAINING IN TD USAGE From an asset weighted perspective organic growth in active TD usage is 3.8% versus the solid growth of passives in TD usage with organic growth of +20.1% DATA SOURCE: MORNINGSTAR HEDGEYE 36

37 ETFS MORE ROOM TO DISRUPT Monthly organic growth in TROW Target date funds, although still positive, is assuming the same downward trajectory as the non-target franchise which is indicative of Passive penetration and early Baby Boomer runoff DATA SOURCE: MORNINGSTAR HEDGEYE 37

38 FINANCIAL SERVICES DEFLATION Target Date fund pricing was stable up until 2010 but is now succumbing to normal Financial Services deflation. Pricing has now dropped precipitously since 2011 DATA SOURCE: MORNINGSTAR HEDGEYE 38

39 LOW COST PROVIDERS ARE STABLE The low cost providers that utilize passive products have stable pricing versus the active providers which are adjusting pricing downward. There is a vast 40 bps difference in active v. passive pricing DATA SOURCE: MORNINGSTAR HEDGEYE 39

40 THROUGH VERSUS TO IN TD Allocations in To target date funds utilize the glide path or automatically rebalancing between equities and fixed income To the investors retirement date. Hence, with a shorter investment horizon, To allocations tend to have more fixed income and less equity allocations. Allocations in Through target date funds allow the glide path to assign asset allocation Through retirement potentially adding years to an investment horizon and thus may contain more equity allocations because of the longer time period to invest and an investors tolerance for the higher historical risk of stocks. TO VERSUS THROUGH IN TARGET DATE Glide path allocations to retirement stop allocating on a specific date versus through allocations which continue to move between stocks and bonds through your retirement years which means more stocks typically. DATA SOURCE: BLACKROCK HEDGEYE 40

41 THROUGH VERSUS TO IN TD Through allocations in target date tend to result in equity allocations well into the 60% range versus To allocations which are more consistently between 50-60% DATA SOURCE: MORNINGSTAR HEDGEYE 41

42 THROUGH VERSUS TO IN TD And performance and hence Morningstar ratings tend to be higher with Through with higher equity percentages versus To with higher about of lower yielding fixed income. DATA SOURCE: MORNINGSTAR HEDGEYE 42

43 THROUGH VERSUS TO Through allocations average 62.9% allocation to equities across the industry according to Morningstar versus 56.6% in To allocation. TROW specifically currently has 66.2% allocation to stocks DATA SOURCE: MORNINGSTAR HEDGEYE 43

44 THROUGH VERSUS TO IN TD But with higher equity allocations, TROW target date, and its Through allocations can have significant windows of under performance. DATA SOURCE: MORNINGSTAR HEDGEYE 44

45 THROUGH VERSUS TO IN TD And performance in target date funds does impact flows with under performance versus Morningstar averages rolling net new money to lower levels historically. DATA SOURCE: MORNINGSTAR, COMPANY DATA HEDGEYE 45

46 TD THE ONLY HORSE IN THE STABLE What was once stable balance in flows through the end of 2012 with non target date funds averaging $4B in inflow with TD at $2B per quarter has turned on its head to -$4B for regular funds and $3.4B for TD. DATA SOURCE: COMPANY DATA HEDGEYE 46

47 TD THE ONLY HORSE IN THE STABLE And with the rest of the franchise in decay or with negative growth, Target date funds become more important and once double digit growth rates are now in mid single digits. DATA SOURCE: COMPANY DATA HEDGEYE 47

48 TD THE ONLY HORSE IN THE STABLE And the 4 quarter moving average gives the fairest picture of rolling annual trends and high teens growth in TD is threating to break into single digits. DATA SOURCE: COMPANY DATA HEDGEYE 48

49 TD THE ONLY HORSE IN THE STABLE And although +10% growth in target date funds is nothing to sneeze at, target date is still only 22% of AUM which won t cover the hole in the non target date retirement business. DATA SOURCE: COMPANY DATA HEDGEYE 49

50 TD THE ONLY HORSE IN THE STABLE And looking at that Phase Transition from 2012 onwards and high single digit firm wide growth moving to mid single digits now moving to just 0.80% growth as of the most recent quarter. DATA SOURCE: MORNINGSTAR HEDGEYE 50

51 THE WALL STREET WALTZ DATA SOURCE: BLACKROCK HEDGEYE 51

52 PHASE TRANSITION SINCE 10 DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA HEDGEYE 52

53 PHASE TRANSITION SINCE 10 DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA HEDGEYE 53

54 PHASE TRANSITION DATA SOURCE: COMPANY RELATED DATA HEDGEYE 54

55 AMBIVALENCE BY ANALYSTS/INVESTORS DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA HEDGEYE 55

56 BELOW THE STREET TROW pretax margins are still near peak after a new high water mark in 2014 at 50.3%. Our estimates assume reversion to 46% and 45% thru 2017 which is still above the long term mean of 43% DATA SOURCE:: COMPANY DATA, HEDGEYE RISK MANAGEMENT ESTIMATES HEDGEYE 56

57 BELOW THE STREET Margins could be an important storyline as TROW AUM is about to cross another break point. Mutual fund assets over $500 B will get priced at 27 bps versus 29 bps on assets prior. DATA SOURCE:: COMPANY DATA, HEDGEYE 57

58 BELOW THE STREET Street earnings estimates range from $4.75 to $5.44 for a mean of $4.89 for Our estimate is $4.06, 17% below Consensus with our range including a scenario well below $4 DATA SOURCE: FACTSET, HEDGEYE ESTIMATES HEDGEYE 58

59 ALWAYS A BLUE CHIP PREMIUM While trading at the low end of its historical valuation, TROW still maintains a premium to the rest of the asset management group with a 16.1x forward multiple versus 15.2x for the rest of the sector. DATA SOURCE: FACTSET HEDGEYE 59

60 ALWAYS A BLUE CHIP PREMIUM Thus the long standing premium is at risk with the only growth coming from target date product which is on top of our earnings estimates that are well below consensus. DATA SOURCE: FACTSET HEDGEYE 60

61 RESPONDING TO GROWTH DATA SOURCE: FACTSET, HEDGEYE ESTIMATES HEDGEYE 61

62 PROCYCLICAL IS AS PROCYCLICAL DOES DATA SOURCE: BLOOMBERG, HEDGEYE ESTIMATES HEDGEYE 62

63 RISKS OF A SHORT POSITION All things considered, the asset managers have historically been steady performers across cycle. DATA SOURCE: HEDGEYE ESTIMATES HEDGEYE 63

64 RISKS OF A SHORT POSITION STABILITY All things considered, the asset managers have historically been steady performers across cycle. DATA SOURCE: COMPANY DATA, HEDGEYE ESTIMATES HEDGEYE 64

65 RISKS OF A SHORT POSITION STABILITY All things considered, the asset managers have historically been steady performers across cycle. DATA SOURCE: COMPANY DATA, HEDGEYE ESTIMATES HEDGEYE 65

66 RISKS OF A SHORT POSITION PERFORMANCE Performance at the TROW complex is still top of the industry tables however returns alone are not enough to stem the secular shift out of active management DATA SOURCE: STRATEGIC INSIGHT HEDGEYE 66

67 THESIS: A BLUE CHIP COMPANY WITH BLUE TRENDS 1 2 ACTIVE ONLY IN AN INCREASINGLY PASSIVE WORLD Passive products have only just now cracked low teens in market share and with tailwinds including the DOL Fiduciary rule, continue to threaten the active industry. Large Cap strategies are most at risk and TROW maintains the biggest exposure there. TARGET DATE NOT A BULLSEYE ANYMORE TROW s last bastion of growth is the Target Date (TD) retirement channel but ETFs have also made sustainable inroads there. What was once mid teens growth for the firm in TD is threatening to dip into single digits which will mean flat or negative growth for the overall franchise. Pricing trends continue to soften for the industry in TD which means overtime profitability is coming out too. 3 DATA SOURCE: HEDGEYE ESTIMATES TOP OF CYCLE WITH DOUBLE LEVERAGE TROW is operating at peak historical margins with market appreciation generating all the net new assets at the firm. This is a dangerous gambit for investors with the firm rolling to lower margins and relying 100% on continued gains in equities to raise overall AUM levels. With no meaningful fixed income business or Passive suite to soften any downturn, the firm s results have unappreciated negative leverage. HEDGEYE 67

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