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Strong Q3 market gains should help traditional asset managers' earnings

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Strong Q3 market gains should help traditional asset managers' earnings

Despite continued pressure on growth and expenses, analysts expect to see earnings improvement from most of the large publicly traded traditional asset managers.

Third-quarter earnings per share are expected to climb year over year for a majority of the 15 largest traditional asset managers by market capitalization, according to analyst estimates collected by S&P Global Market Intelligence.

Analysts forecast improved fee income and a moderation of the trend that has seen clients pulling assets out of of actively managed strategies in favor of lower-fee passively managed investments.

BlackRock Inc. opened the quarterly earnings season announcements among major publicly traded asset managers reporting 14% revenue growth year over year. The improvement was partly due to an increase in investment advisory performance fees to $191 million, more than triple the line for the 2016 third quarter.

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BlackRock's strong year-over-year gains are expected to be an outlier in an industry analysts believe will show flat overall growth.

"We expect organic long-term growth in [the third quarter] remained anemic overall, but should improve at several firms," Keefe Bruyette & Woods analyst Robert Lee wrote in an Oct. 8 research note to clients.

The investment trend away from active management has mitigated this year, and more than half of active managers in the space have outperformed their benchmarks through the end of the quarter, Jefferies analyst Daniel Fannon wrote in an Oct. 10 note.

But longer term, Fannon said, "concerns around passive encroachment and regulatory uncertainty remain."

Fee revenues are expected to benefit because they are linked to assets under management, which grow with stock market gains, analysts said. Lee said investors in companies reliant on active management will look for earnings improvement beyond growth in AUM, which largely reflect the rising securities markets. "Each company has to demonstrate like Eaton Vance Corp. has that there's enough other things going on in their business that can compensate for those pressures," he said.

New money invested in low-cost, passive investment funds accelerated during the quarter, partly driven by the retail market, according to CFRA analyst Todd Rosenbluth. Not all that growth is attributed to assets formerly invested in active strategies. Rosenbluth said there is a shift among advisers in the wealth management space towards adopting exchange-traded funds, as in-house ETF-based asset allocation models become more popular. BlackRock and Invesco Ltd. are the most heavily exposed to both the active and passive investment market, he said.

Even if flows improve, asset managers will still face headwinds on fees. Analysts are looking to the group's third-quarter results for more clarity on costs, as several companies presaged higher expenses during the second half of 2017. Fannon said companies in the space face regulatory expenses and costs from much-needed technology upgrades.

Credit Suisse analyst Craig Siegenthaler expects more detail from third-quarter earnings on how European regulations like the Markets in Financial Instruments Directive, or MiFID II, will impact asset managers. MiFID II aims to level the playing field between financial services firms through better pricing transparency, to provide more protection for investors and to set controls on algorithmic trading. It is slated to take effect in 2018, though there is some uncertainty about how it will apply to U.S. institutions.

"Most of the asset managers in our coverage with European businesses have indicated that they will be absorbing research costs into their [profit and loss statements]," Siegenthaler wrote in an Oct. 3 research note, pointing to names like BlackRock and Invesco that he expects will face margin pressure starting in 2018. "While our models already account for these costs, we look for additional color from management in the upcoming quarters to sharpen our assumptions."

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