UPDATE 5-Waddell & Reed fund inflows fall sharply
* Q2 net inflows $731 mln vs Q1's $2.8 bln
* Cites weak performance of largest funds
* Was large seller of futures contracts in May flash crash
* CEO says economic double-dip seems unlikely
* Waddell shares down 3.1 pct (Adds CEO interview, rewrites first paragraph to mention flash crash)
By Ross Kerber
BOSTON, July 28 (Reuters) - Asset manager Waddell & Reed Financial Inc (WDR.N) said its quarterly results were hurt by subpar performance in its flagship fund, which flipped abruptly to outflows in May and June after markets were shaken by the "flash crash".
Waddell moved to the center of the flash crash controversy after news it sold a large number of equity futures contracts on May 6, when equity markets briefly tumbled in an unprecedented fashion.
There has been no suggestion that Waddell was at fault but firm executives on a conference call on Wednesday acknowledged the flash crash may have had an impact on its fund flows.
The Kansas City firm reported net inflows of $731 million for the second quarter, down from $2.8 billion in the first quarter. It cited investors' reluctance to invest in equities amid economic uncertainty.
Waddell shares were down 3.1 percent in afternoon trading to $23.91.
Still, second-quarter net income rose to $34.2 million, or 40 cents per share, from $23.4 million, or 27 cents per share, a year earlier. Revenue increased 29 percent to $257.2 million on higher assets and investment management fees.
Analysts on average had expected 41 cents a share, according to Thomson Reuters I/B/E/S, though several said the company would have beaten their estimates except for a charge of 2 cents a share to account for higher taxes tied to reserves.
Analysts had priced in lower fund inflows, and some had feared an even deeper drop after the flash crash and performance problems.
"We knew there was going to be a decline in terms of volume," said Sandler O'Neill analyst Michael Kim, who had expected fund inflows of just $100 million for the quarter and earnings of 39 cents per share.
"At the end of the day, it was better than what we had expected," he said.
The company told analysts on the conference call that the flow picture was still mixed in July for its biggest fund, Ivy Asset Strategy. Through Tuesday, the company's shares have fallen 19 percent this year, almost twice the decline of a Dow Jones index of U.S. asset managers .DJUSAG.
Having inflows at all will be helpful to the company, as some competitors have reported outflows for the quarter, including Legg Mason Inc (LM.N) and Janus Capital Group (JNS.N). Other asset managers have reported inflows, including T. Rowe Price Group (TROW.O) and Invesco Ltd (IVZ.N).
Total Waddell assets stood at $68.3 billion on June 30, down from $74.2 billion at the end of March. Those levels are far below first-tier asset management companies like Fidelity Investments and Vanguard Group Inc, each with over $1 trillion in assets.
But the results were closely watched by Wall Street both because of the flash crash and because of Waddell's rapid growth in recent years.
Waddell did not break out second-quarter flows by fund, though an earlier analysis by Lipper, a Thomson Reuters unit, showed Ivy Asset Strategy had net outflows in May and June totaling $362.9 million, after inflows in the four previous months.
Reviews of the May 6 flash crash identified Ivy Asset Strategy as a large seller of future contracts that day, though regulators have since focused on other areas.
"Certainly the publicity we received surrounding the flash crash didn't help," said Ivy Asset Strategy fund manager Michael Avery, who is also the company's chief investment officer.
"I think the anxiety was misplaced," Avery added. "People who understand the market and how we manage the fund have dismissed it as a non-event. But it certainly didn't help, particularly as far as people thinking of new allocations into the fund."
In an interview, Waddell Chief Executive Henry Herrmann said it was hard to separate how much the flash crash affected flows compared to money that was pulled away from equity funds in general because of volatile markets.
"The market was in a down trend and that may have aggravated it (the outflow from Ivy) to some extent, but the magnitude of the degree is impossible to assess," he said.
Herrmann acknowledged that the performance of Ivy Asset Strategy has fallen short of peers for the year to date. But said he is comfortable with Avery's strategy emphasizing big bets on Asia and some large-cap stocks.
"You have to take a stand in an environment like the one we're in," Herrmann said.
A new downturn in the economy -- a so-called "double-dip" -- seems unlikely, Herrmann said.
Instead he predicted a graph of the economy would resemble the mathematical symbol for a square root -- a sharp decline, then a sharp recovery, and a period of sluggish growth of likely between two to three percent for a while. (Reporting by Ross Kerber; editing by John Wallace and Tim Dobbyn)
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