FOOL ON THE HILL
An Investment OpinionBy
NVESTing for the Future Warren Gump (TMF Gump)
December 14, 1999
For a couple of years, I've had my eye on NVEST, LP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NEW)") else Response.Write("(NYSE: NEW)") end if %>, a money management firm that I find noteworthy. Because of its unusual structure and the lack of a catalyst to turn the stock around, however, I haven't taken the time to write about it. Anyone who might consider stocks written about in this column would have benefited from this restraint: so far this year, the stock has lost 30% of its value. After this decline, NVEST is trading at a price/earnings ratio of less than 10x current year earnings with a dividend yield of about 14%. Combining this low valuation with the company's solid position in the lucrative money management business, the stock has many appealing attributes.
Now, you're probably wondering where in the world I found a company named NVEST? Has anyone ever heard of it? The company is unknown because it's a holding company for a group of money managers that operate under their own names. Have you ever heard of Loomis Sayles? They're an NVEST affiliate (and represent about half of the company's assets). What about the Oakmark mutual fund family? The manager for these funds is Harris Associates, another NVEST company.
In addition to those two well known firms, NVEST controls several other companies: AEW Capital Management; Back Bay Advisors; Jurika & Voyles; Reich & Tang; Snyder Capital; Vaughan, Nelson, Scarborough, & McCullough; and Westpeak Investment Advisors. NVEST also has a 50% interest in Capital Growth Management, the manager for the CGM mutual fund family.
An observant person would logically be wondering at this point how a money manager could be doing poorly. Aren't we in the midst of one of the greatest markets of all time? Hasn't the S&P 500 index returned more than 20% for four consecutive years, with a shot of making it a fifth? This has got to be the best of times for people who are managing money.
Alas, that is not true for all industry participants. While the overall major indices have been surging, that performance has been focused on a select number of companies and sectors, particularly those with a technology and telecommunications emphasis. Through last Friday, the Nasdaq Composite index, which includes lots of those favored companies, is up a phenomenal 66% for the year. In comparison, the S&P 500 index is up only 16% this year, 50 percentage points lower than the Nasdaq.
The difference between "growth" and "value" sectors within the S&P 500 (and other market sectors) has also been dramatic. The Vanguard Growth Index, which represents the companies in the S&P 500 with the highest price-to-book ratios (a characteristic of most growth stocks), is up 23% this year, whereas its Value Index cousin, representing lower price/book stocks, has only returned 9% this year.
As you might have now deduced, NVEST has an emphasis on the value sector of the market, with around 60% of equity assets under management invested in this style. With a major portion of its managed assets lying in such a lackluster area, it isn't too surprising that the company's $54 billion in equity assets is down $1 billion from a year ago. Internally generated price appreciation has been minimal and some clients have decided to reallocate their money to better-performing sectors.
This emphasis on the value sector will be problematic as long as the sector's relative performance stinks. That being said, market moods are notoriously fickle and history has repeatedly demonstrated the benefits of value investing. The dramatic underperformance of this style is unlikely to be permanent and NVEST should be well-positioned to enjoy its rebound.
NVEST also has a major presence in the fixed income market with nearly $56 billion under management. Although management fees for this asset class are well below those of equities, this business has a stabilizing effect on the company's income stream due to the traditionally lower sector volatility. Even though MetLife (a major NVEST shareholder) pulled $3 billion in fixed assets out of NVEST-affiliated firms in preparation for its pending public offering, NVEST was able to increase fixed income assets by $1 billion over the past year.
Reflecting the challenges in the company's equity business, earnings per share (EPS) during the first nine months of the year were only up 3% to $1.49 from $1.44. For the third quarter ending in September, EPS were flat at $0.50 cents. While flat earnings aren't anything to get really excited about, it certainly is preferable to a major decline. Analysts project a slight earnings drop in the next two quarters, followed by a modest rebound thereafter.
Several things could help turn around NVEST's results over the next few years. The most dramatic would be a return to favor of the value investing style. In such a situation, the company would benefit from internal asset growth (price appreciation), as well as an inflow of new money. Continued improvement in international equity markets could also boost results, as Oakmark has a strong presence in that area. Of course, those events are market-dependent and not really attributable to management decisions.
The NVEST management team is taking steps to resuscitate its business. One of the bigger events of the year is a joint venture with Tokyo's Asahi Life Asset Management to manage assets. During the third quarter, this effort brought in $400 million in assets under management. The Loomis Sayles unit is also active in Japan, bringing in $200 million in new assets through subadvisory relationships with Japanese firms. On top of these international moves, the company in June acquired the Kobrick mutual fund family, which has $200 million in growth-oriented assets under management. The company is also working to achieve synergy between its units: Oakmark named NVEST Services as its transfer agent earlier this year, bringing this function in-house.
While waiting for NVEST's business to enter a strong growth period, investors are being rewarded with a hefty 14% dividend yield. This high yield results from NVEST's master limited partnership (MLP) structure, which allows the organization to avoid most federal income tax, but requires that most income be paid out on an annual basis.
Some people are surprised to see that the company pays out more in dividends than it earns -- the company paid a $0.63 per share third quarter dividend, yet earnings were only $0.50 per share. This is possible due to the large amounts of non-cash amortization (related to prior acquisitions) that hits the company's income statement. Although this charge reduces reported net income, it does not result in any cash payment. Operating cash flow, which adds this amortization and non-cash compensation to net income, is about 10% greater than the dividend. This excess cash flow is used to fund new opportunities.
Basically, NVEST is an inexpensive investment in some top-notch money management firms. The company has struggled with extraordinary market conditions, but it's hanging on and waiting for market conditions more conducive to its investing style. There's no telling when that time will come, but investors will enjoy a hefty dividend until it happens.
(One caveat... due to the MLP structure, NVEST shareholders will receive a K-1 statement instead of a 1099-Div for dividend payments. This makes filling out your income statement more complicated than owning a regular company. To partially mitigate this issue [and defer paying ordinary income taxes on the high dividend yield], I would strongly encourage putting any NVEST investment a into tax-deferred account like an IRA rather than a fully taxable account.)