Investors have steadily shifted from active mutual funds toward low-fee index funds, with active funds’ share of AUM falling from 82% in 2009 to 49% today.

Despite this trend and scepticism about active managers, Artisan Partners (APAM) stands out by retaining veteran portfolio managers, growing AUM to $162 billion, and delivering strong profitability.

Yet, the market prices in a decline in returns for the firm.

A rotation back from private markets into liquid public investments could boost Artisan’s AUM and earnings, making it a compelling opportunity.

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There has been a significant amount of news and articles recently about the shift to passive investment strategies and the decline of active equity management.

That is true to a very large extent.

Actively managed mutual funds constituted 82% of the funds’ total net assets under management (AUM) in 2009, while index ETFs and index mutual funds constituted the rest.

Currently, these ratios are 49% and 51%, respectively.

Funds are only a small part of the whole market. However, these ratios clearly show investors’ preferences.

As many hedge funds fail to generate significant excess returns, investors are becoming more convinced that investing in passive indices is a better idea.

Another reason for this shift is fees.

Hedge funds typically charge fees for assets under management and annual performance, whereas index funds and ETFs have very low fees and no performance fees.

However, this does not mean that there are no successful exceptions in the active investment management space.

Investors can take advantage of depressed valuations to consolidate the good ones and get value and high returns.

One good example of this is Artisan Partners (APAM).

The asset management firm invests in public equity, non-investment grade corporate bonds, and secured and unsecured loans across the globe.

The firm has a long history of attracting and, more importantly, retaining top-tier portfolio managers.

Many of its fund managers have been with the firm for over two decades, often since launching their respective funds.

Consistent leadership within funds builds trust and confidence among both institutional and individual clients.

When clients see positive, long-term results, they are more likely to remain invested and allocate additional capital.

The firm’s latest earnings show its operational strength. Artisan reported revenue growth of 5% from the prior year, and the adjusted operating income was up 9%.

When clients see positive, long-term results, they are more likely to remain invested and allocate additional capital.

This was driven by an 8% increase in average AUM, which reached $162 billion.

Furthermore, Artisan operates an asset-light business model. Its primary assets are its people and its investment processes. This structure translates into high profitability.

All these factors combined enabled the company to achieve a 30% Uniform return on assets ”ROA” last year, coupled with a robust 16% Uniform asset growth.

However, the firm trades at a lowly 9.4x Uniform P/E, reflecting concerns about competitive pressures in the asset management space and declining actively managed AUM.

We can see what the market thinks through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s Uniform ROA to decline to around 10% from 30% last year.

A significant potential tailwind for the firm lies in the changing sentiment around private assets.

In recent years, vast sums of capital have flowed into illiquid investments like private equity and venture capital.

Amid recent market volatility and a higher-for-longer interest rate environment, many investors are growing more skeptical of these private investments, which often lack transparency and are difficult to exit.

Should this trend continue, investors may begin to shift their allocations back toward the liquidity and transparency of public markets.

As a specialist in public equity and fixed-income, Artisan Partners is perfectly positioned to benefit from such a rotation.

Increased flows into public market funds would directly boost the firm’s AUM, driving further growth in revenue and earnings.

While competitive pressures are real, the modest valuation appears to already account for them.

The potential for a strategic shift in asset allocation from private to public markets provides a clear catalyst for future growth, making the firm a noteworthy case for consideration.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research