Growth Probable Despite Weakening Economy

Banks have stumbled, brokerages are shrinking and even insurers are feeling the pinch of a weak economy. Are mutual funds about to become the next crack in the financial services mosaic? Some people apparently think so.

Investors have been unloading the common stock of publicly traded fund companies for much of the past year. An index of these stocks tracked by Lipper Analytical Services dropped 13.7% in 1990, under-performing most popular market averages.

Fund companies are finding it harder to attract investor dollars, with competition and costs on the rise. During the 1980s, industry assets under management surged to $982 billion from $94.5 billion--better than a 26% annual growth rate. A report prepared for the Investment Company Institute predicts growth of about 12% a year during the 1990s.

Diminished expectations partly explain why the stocks have fallen. In addition, they’ve been tainted by problems elsewhere in the financial services industry.

“There’s been a broad-brushed painting of the entire financial sector as down and out,” says Dean P. Eberling, a senior analyst for Shearson Lehman Hutton in New York.

Yet such blanket pessimism isn’t justified, Eberling and several other observers say. The fund business remains fundamentally healthy and should continue to grow faster than the general economy. Most of these firms have little or no debt--a good trait for a recession. At current prices, certain strong, well-known companies in the group could be a good place to invest for aggressive individuals willing to hold for a couple years, if necessary.

Clearly, the business has potential. Mutual fund companies earn most of their income from fees on the assets they manage, and this trend remains positive. Most publicly traded fund companies operate solidly in the black, and many continue to post record earnings. “Revenues for the most part have held up well,” says A. Michael Lipper, head of Lipper Analytical. Although rising expenses have crunched profit margins a bit, they remain generally good, he says.

Fund companies typically offer at least one money market portfolio to which investors can move. Although these products generate lower fees compared to equity and bond funds, they at least help the companies retain customers when the financial markets sour.

Nevertheless, some groups will have an easier time than others during rough periods. “The key issue is the diversity of each company’s product lines and asset-class exposure,” Eberling says. Firms that offer a balanced mix of stock, bond and money market funds will tend to enjoy more revenue resiliency.

One problem that investors face is a scarcity of fund management companies from which to choose. Of the more than 300 fund groups, most either are private outfits or are owned by brokerages, insurers, banks or other companies. “The fund business has generally developed as part of other businesses,” Lipper explains. Eberling counts only 15 reasonably pure fund-management companies that are publicly traded.

Of these, his favorite is Franklin Resources, holding company for the Franklin Group of Funds. That choice is seconded by Scott Offen, portfolio manager of Fidelity’s Select Brokerage & Investment fund in Boston. Franklin has a capable, lean management, they say. And its product mix, which emphasizes taxable as well as tax-free bond and money market funds, is positioned to hold up well in a recession.

Charles B. Carlson, vice president and editor of the Dow Theory Forecasts newsletter in Hammond, Ind., likes Dreyfus Corp. The company’s assets under management jumped strongly in 1990, yet earnings have ebbed because of a tough battle with privately held Fidelity Investments, both of which are trying to offer superior money market yields by cutting fees.

“In an increasingly competitive environment, a company that can keep costs down and gain market share will come out ahead,” Carlson says. He considers Dreyfus to be cash-rich and rates the company as his only recommendation among fund-management stocks.

Eberling, however, sees more selling pressure on Dreyfus, which has fallen roughly 30% from a 1990 high of $38.50 a share. After Franklin, his favorites include T. Rowe Price Associates, Alliance Capital Management and Oppenheimer Capital. Offen views Eaton Vance Corp. and Colonial Group as cheap at current prices, although he doesn’t expect these smaller companies to boost assets under management at the same rate as Franklin.

That Franklin, Dreyfus and others in the group trade well below their 1990 highs says something about the volatility of these stocks. There was a time not long ago when the common shares of fund management outfits were just about the hottest tickets on Wall Street--better even than the funds the companies offered. In 1985, for instance, Franklin Resources surged 410% and Dreyfus rose 129%.

Hardly anyone expects to see such sharp advances again. One reason the stocks soared during the mid-’80s, Lipper explains, was that people expected banks to buy up fund companies as liberalized federal regulations allowed them to do so. But with the prices of bank stocks down sharply now, it’s less likely that they could afford to acquire a fund company.

Rather than takeovers, investors should focus on the fund industry’s ability to increase assets under management. And in this respect, the long-term trend remains favorable. With the U.S. population maturing and people becoming increasingly averse to taking on debt, the pool of cash available for investing and saving should increase.

With banks and other financial institutions mired in their own problems, Offen predicts that mutual funds will enjoy a competitive advantage, especially on yield-sensitive products such as money market portfolios.

Eberling also believes that the stocks offer good values at current prices. “The industry is poised to perform well in the ‘90s,” he says.

FALLEN STARS

If you bought stock in a mutual fund management company a year ago, you probably lost money. The stocks in this group got bruised in 1990, with the 10 issues tracked by Lipper Analytical Services losing 13.7% on average.

Even so, most of these companies are solidly profitable, with little or no debt. Besides, the mutual fund business remains healthy and should pull through the recession in good shape. For these reasons, the stocks can make sense for aggressive investors with an eye to the future. Here’s key information on the six biggest:

Friday’s 52-Week Company Price High P/E 1990 EPS Alliance Capital Mgmt. $16.125 $17.375 14 $1.75* (+11%) Dreyfus Corp. 27.125 38.50 8 1.55* (-23%) Franklin Resources 30.125 35.875 13 2.28 (+14%) Oppenheimer Capital 13.50 17.375 8 1.60* (+13%) T. Rowe Price Assoc. 20.50 31.50 13 1.63* (-21%) United Asset Mgmt. 14.75 21.00 15 1.03* (+10%)

Company Dividend Alliance Capital Mgmt. $1.74 Dreyfus Corp. 0.52 Franklin Resources 0.46 Oppenheimer Capital 1.70 T. Rowe Price Assoc. 0.64 United Asset Mgmt. 0.46

All of these companies trade on the New York Stock Exchange except for T. Rowe Price, an over-the-counter issue.

* Earnings estimates by Shearson Lehman Hutton.