Growth And Then Some

This sector could be set for a supercharged recovery.

Our Foolish philosophy has long been to favour a cheap index tracker over an expensive actively managed fund if you want a one-stop investment in a mainstream equity market. 

The reasons are simple: high costs are a nasty corrosive of investment returns and very few actively managed funds turn out to be winners in the long run.

Nevertheless, there always seems to be a new generation of investors ready to be seduced by the fund industry's glitzy world of 'star' managers, 'market-beating' (short-term) returns and 'hot' new fund launches.

But hang on, let's look at this from another angle. If there's constant demand for the products of fund companies, are these firms themselves a good investment? In particular, are they a good investment right now?

How fund management companies work

The business of fund companies is really quite simple: increase assets under management (AUM), keep the cost base low, and watch as management fees -- and ultimately profits -- grow exponentially.

AUM can be increased in three ways: net sales growth (investors put more money into the funds than they take out), fund performance (assets increase in value), and acquisitions (assets are bought in).

In times when asset prices are falling, fund management companies tend to get hit with a double whammy of deteriorating fund performances and increasing outflows as investors head for the exit. Their share prices can get slaughtered.

When asset prices are rising, the reverse happens. And that's what makes fund management companies interesting right now.

If you believe the world's nascent return to growth isn't just a flash in the pan, fund management companies effectively offer a geared play on a sustainable recovery.

Which companies?

I've picked out four companies from the FTSE 350 that I think fit the bill. 

I've passed over the more exotic and niche operators and gone for those with a broad range of funds and good exposure to the high-margin retail investor market. These are companies whose products you'll find at just about every online fund supermarket.

^{* Quarterly figures from latest reported quarter}

All four companies have increased AUM due to their funds' performance since last March. Schroders is so far the only one to have started to enjoy the additional benefit of net inflows of cash into its funds.

Aberdeen and Henderson have both added to AUM by significant acquisitions in the past 12 months. Aberdeen acquired assets from Credit Suisse and Royal Bank of Scotland (LSE: RBS), while Henderson bought the ill-fated New Star Asset Management.

F&C is currently looking at an acquisition.

Valuations

On forward P/E and dividend yield, the market is rating FTSE 100 constituent, Schroders, at a premium, twinning Aberdeen and Henderson as solid middle siblings, and discounting F&C as a bit of a problem child. I reckon the relative ratings are about right. As such the companies offer different options for different investor risk appetites -- or taken together a decent spread across the risk range.

But the crucial point is that analysts simply aren't forecasting a strong growth scenario in the sector. Most have earnings-per-share two years ahead pencilled in well below pre-bear market levels.

If the global recovery proves sustainable, expect to see fund companies' share prices race ahead of the broader market with repeated earnings upgrades as analysts scramble to keep up with the double turbo drive of improving fund performance and money inflows.

Who says high fund fees are a bad thing for investors? They're not if you're an investor in a fund management company when asset prices are on the rise!

More from G A Chester:

• Riding The Bull Market
• Beating The Bear

The author owns shares in Schroders.