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T. ROWE PRICE (TROW)
March 2016
JONATHAN CASTELEYN, CFA JOSHUA STEINER, CFA
PADDLING UPSTREAM – BEST IDEAS SHORT
HEDGEYE 2
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 www.hedgeye.com
DISCLAIMER
HEDGEYE 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 5 DATA SOURCE: COMPANY DATA, BLOOMBERG, HEDGEYE ESTIMATES
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.
HEDGEYE 6 DATA SOURCE: COMPANY DATA, BLOOMBERG, HEDGEYE ESTIMATES
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.
HEDGEYE 7
THESIS: A BLUE CHIP COMPANY WITH BLUE TRENDS
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.
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.
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DATA SOURCE: HEDGEYE ESTIMATES
HEDGEYE 8 DATA SOURCE: BLACKROCK
THE ETF ASTEROID IS SPEEDING UP
THE DOMINANCE OF INDEXING IS ACCELERATING
HEDGEYE 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 10 DATA SOURCE: COMPANY DATA, WISDOMTREE, BLOOMBERG
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.
Equity ETFs $1,300
Equity Mutual Funds ($390)
Equity ETFs $1,347
HEDGEYE 11 DATA SOURCE: ICI, BLOOMBERG
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.
HEDGEYE 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 13 DATA SOURCE: MORNINGSTAR DIRECT, BLOOMBERG
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.
HEDGEYE 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 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 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 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 18
DOL FIDUCIARY RULE IS ONEROUS The source of the forthcoming DOL Fiduciary Rule is that a simple study of 3rd 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 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 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 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 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%.
DATA SOURCE: MORNINGSTAR DIRECT
Industry Average
HEDGEYE 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 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 3rd party distribution via the 12b-1 fee.
DATA SOURCE: CERULLI ASSOCIATES
HEDGEYE 25 DATA SOURCE: T. ROWE PRICE
DOL FIDUCIARY RULE IS ONEROUS
RECENT 10-K DISCLOSURE
TROW’s most recent annual filing outlined that 45% of its AUM is distributed by 3rd party intermediaries
HEDGEYE 26
TARGET DATE NO BULLSEYE ANYMORE
HEDGEYE 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 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 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 30 DATA SOURCE: DEPARTMENT OF LABOR, CERULLI ASSOCIATES
BUT OVERALL DC IS NOW IN OUTFLOW
HEDGEYE 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 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 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 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 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 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 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 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 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 40 DATA SOURCE: BLACKROCK
“THROUGH” VERSUS “TO” IN TD
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.
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 10-20 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.
HEDGEYE 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 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 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 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 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 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 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 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 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 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 51 DATA SOURCE: BLACKROCK
THE WALL STREET WALTZ
HEDGEYE 52 DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA
PHASE TRANSITION SINCE ‘10
HEDGEYE 53 DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA
PHASE TRANSITION SINCE ‘10
HEDGEYE 54 DATA SOURCE: COMPANY RELATED DATA
PHASE TRANSITION
HEDGEYE 55 DATA SOURCE: BLOOMBERG, COMPANY RELATED DATA
AMBIVALENCE BY ANALYSTS/INVESTORS
HEDGEYE 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 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 58
BELOW THE STREET Street earnings estimates range from $4.75 to $5.44 for a mean of $4.89 for 2017. Our estimate is $4.06, 17% below Consensus with our range including a scenario well below $4
DATA SOURCE: FACTSET, HEDGEYE ESTIMATES
HEDGEYE 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 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 61 DATA SOURCE: FACTSET, HEDGEYE ESTIMATES
RESPONDING TO GROWTH
HEDGEYE 62 DATA SOURCE: BLOOMBERG, HEDGEYE ESTIMATES
PROCYCLICAL IS AS PROCYCLICAL DOES
HEDGEYE 63
RISKS OF A SHORT POSITION All things considered, the asset managers have historically been steady performers across cycle.
DATA SOURCE: HEDGEYE ESTIMATES
HEDGEYE 64 DATA SOURCE: COMPANY DATA, HEDGEYE ESTIMATES
RISKS OF A SHORT POSITION
STABILITY
All things considered, the asset managers have historically been steady performers across cycle.
HEDGEYE 65 DATA SOURCE: COMPANY DATA, HEDGEYE ESTIMATES
RISKS OF A SHORT POSITION
STABILITY
All things considered, the asset managers have historically been steady performers across cycle.
HEDGEYE 66 DATA SOURCE: STRATEGIC INSIGHT
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
HEDGEYE 67
THESIS: A BLUE CHIP COMPANY WITH BLUE TRENDS
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.
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.
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DATA SOURCE: HEDGEYE ESTIMATES
FOR MORE INFORMATION, CONTACT US AT:
[email protected] (203) 562-6500