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Morningstar | Waddell & Reed Closes Out 2018 With a Thud as AUM Declines 19% in the December Quarter

A confluence of several issues--poor relative active investment performance, the growth and acceptance of low-cost index-based products, and the expanding power of the retail-advised channel--has made it increasingly difficult for asset managers running predominantly active portfolios to generate organic growth, leaving them more dependent on market gains to drive assets under management higher. While we still believe there will be room for active management, which is hard to do in an environment where an overwhelming majority of the flows are going into index funds and exchange-traded funds, we believe the advantage when it comes to getting placement on platforms will go to asset managers with greater scale, established brands, solid long-term performance, and reasonable fees.With $65.8 billion in total AUM at the end of 2018, Waddell & Reed should have the size and scale necessary to be competitive, but with more than three quarters of managed assets tied up in equity-driven strategies, product distribution more heavily weighted toward the retail side of the business, and no discernible reach outside the United States, the firm is at a disadvantage relative to peers. Given Waddell & Reed's current fund performance levels and its higher-than-average fees, the company will be in the crosshairs in an environment where investors and the advisors that serve them are focused on solid long-term investment performance and reasonable fees.During 2013-17 (2008-17), Waddell & Reed's organic growth rate averaged negative 9.4% (negative 0.4%) with a standard deviation of 12.4% (13.5%). This was far worse than its peers, which generated positive 0.7% (positive 0.8%) average annual organic growth with a standard deviation of 4.3% (6.2%). Given that we expect the firm's headwinds to be stiffer than its peers as we move forward (as well as forecasting a major equity market decline midway through our five-year forecast), we envision Waddell & Reed's organic growth averaging negative 7%-9% annually during 2018-22, with revenue growth and operating margins affected by industry fee compression and the need to spend more to enhance performance and distribution.