You could consider buying the world's largest listed hedge fund manager, if you're confident we're on the cusp of a new bull market.
One business you don't want to be in during a bear market is investment. Telling customers their life savings have plunged in value is a bit like being a builder who must call around when house prices fall to take down the conservatory and board up the loft.
You might think Man Group (LSE: EMG) would do better than most investment firms in a downturn, given its speciality is hedge funds -- an investment strategy sold to customers as a means of diversifying away from equities and aiming for positive returns, irrespective of the markets.
Not so.
Man's various strategies have actually done quite well, relative to index funds. Its investment products beat the global indices over the last calendar year, with the flagship trend-following AHL fund up 33%.
But while its other fund-of-fund products did better than the 40% drop in equities in 2008, they nevertheless posted declines, and Man, which reports in dollars, said that by the end of its financial year to 31 March , funds under management had shrunk from $74.6 billion to $47.7 billion, due to both losses and withdrawals.
This double-whammy resulted in a near-halving of Man's earnings. Ignoring exceptionals such as acquisitions, annual profits fell from $2.1 billion to $1.2 billion.
Green shoots for hedge funds
Man's shares have soared since it revealed those dire numbers. Having fallen by around 80% from their mid-2007 peak to 152p in early March, the shares have risen 28% in the last month alone to hit 255p.
The reason? The same thing that brought Man low -- the stock market, which boomed throughout April. The FTSE is up 14% over the period -- Man is rising twice as fast. Its products may offer an alternative to pure equity exposure, but its shares look like a geared play on a bull market rally.
A sustained upturn will benefit Man in two ways.
A renewed appetite for equities will staunch the outflow of funds Man has suffered, leading to a stabilisation in annual management fees.
Also, Man's various fund-of-funds would likely get a lift from rising stock markets, which would greatly help performance fee revenue that declined by two-thirds last year.
A subsequent recovery in earnings per share would make Man's 12% dividend yield look more credible. It is barely covered by this year's earnings, and while Man has $2 billion of cash to hand (around 55p per share), it's fanciful to think the dividend will escape a future cut without improved earnings.
Who's afraid of the bogey Man?
Net cash, growing earnings -- all very bullish for a company trading on a forecast P/E of less than 7.
First and foremost, a big share price recovery depends on a market rally. The $60 million in cost savings that management are promising will hardly offset another 43% decline in Man's earnings.
If institutions continue to retrench or wealthy investors are hit by more Madoff-style scandals (the Ponzi scheme cost Man's funds $360 million, incidentally), Man will likely suffer.
Then there are the regulatory changes coming on the back of Madoff and other shocks to the financial system. As the £4.3 billion elephant of the industry, Man is best placed to handle more regulation and greater transparency, but there must be a risk to margins.
Changes are already underway. Man has merged two of its investment managers into a new unit, Man Glenwood, as it repositions its institutional business towards so-called managed accounts. These should be popular, but they're costlier to administer and less flexible, and there has to be a risk the integration won't go smoothly.
There are other political risks, too. Man has previously been criticised for the amount of UK corporation tax it pays, which it has put down to the greater size of its Swiss operations. And its London-based managers are probably already browsing through foreign property web sites after the recent rise in the UK's top rate of income tax.
Finally, Man's directors haven't bought shares since last September -- when several made substantial investments via warrants -- despite the price falling by as much as 50% since then.
Off the fence on the hedge fund giant
No one knows what stock markets will do in the short-term, but personally I see positive signs for the global economy and think equities look cheap rather than expensive.
A re-rating to a PE of 12 would put Man's shares well over £4. With the hedge fund giant looking capable of not only surviving but also filling in for departing rivals, I've been topping up at cheaper prices while I can.
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Owain owns shares in Man Group
