UPDATE 3-Waddell & Reed inflows fall further in Q3
* Q3 profit up 21 percent, beats estimates
* Inflows down vs Q2 and year-ago
* Investors sticking with Asset Strategy fund, exec says
* Concern about possible "political gridlock"
* Shares up 4 percent (Recasts with conference call, share move, byline)
By Ross Kerber
BOSTON, Oct 26 (Reuters) - Asset manager Waddell & Reed Financial Inc (WDR.N) said net inflows fell further in the third quarter, but profit topped expectations and investors have stayed with its much-scrutinized Asset Strategy fund.
"Redemption activity has normalized" for the fund, Chief Marketing Officer Thomas Butch said on a conference call with analysts who pressed for details.
"What we have heard from holders of the product has been broad-based support," Butch added.
Waddell & Reed shares were up 4 percent in midday trading.
The company came under scrutiny after trades by Asset Strategy and other funds were identified as precipitating the stock market's May 6 "flash crash." The Overland Park, Kansas, company previously said the event may have discouraged inflows, which tumbled to $731 million in the second quarter from $2.8 billion in the first quarter.
The decline continued in the third quarter, the company reported on Tuesday. Inflows totaled $658 million, down 10 percent from the second quarter and down from $2.4 billion a year earlier.
In comparison, Janus Capital Group (JNS.N) last week reported net outflows for the quarter, but Affiliated Managers Group (AMG.N) on Tuesday reported net inflows of $5.5 billion.
Regulators did not fault Waddell & Reed for the flash crash, in which the Dow Jones industrial average plunged 700 points in just minutes, exposing flaws in the electronic marketplace dominated by high-speed trading.
Waddell & Reed said third-quarter net income increased to $40.5 million, or 47 cents a share, from $33.4 million, or 39 cents a share, a year earlier.
Analysts surveyed by Thomson Reuters I/B/E/S had expected, on average, 43 cents a share.
Despite the earnings beat, some analysts remained cautious about the company's outlook.
"We expect WDR's flows to remain relatively modest (barring a powerful equities rally), given collateral damage related to recent negative headlines," Sandler O'Neill analyst Michael Kim wrote in a note to investors. He rates the stock "hold."
Later, Kim told Reuters that Butch's comments on inflows were reassuring.
Asset Strategy took in $216 million during the third quarter, according to previous Lipper data, a turnaround from the weeks just after the flash crash. The fund is among a growing number of "flexible portfolio" funds allowed to invest in a wide range of securities, including metals and futures, more like a hedge fund than a traditional mutual fund.
Its performance tailed off in May and June compared to peers, though Lipper data also show its third-quarter performance improved. The test now is whether Asset Strategy can keep posting good results to consolidate its comeback.
"People have put a lot of money into the fund and are holding on to it, but obviously people with new money are being more cautious," said Stifel Nicolaus analyst Jeffrey Hopson.
Waddell & Reed Chief Executive Henry Herrmann said in a statement that third-quarter inflows came despite "poor investor sentiment toward equities."
Assets under management rose to $76 billion at Sept. 30 from $64 billion a year earlier, and since then have risen to just under $79 billion, Herrmann said on the conference call.
On the same call, Asset Strategy manager Michael Avery did not discuss trading in May, though he previously acknowledged his funds were being reviewed by regulators.
Asked about the upcoming U.S. elections, in which Republicans are expected to make gains in the U.S. Congress, Avery said potential policy gridlock in Washington might not be as good for the financial industry as some contend.
"Gridlock is good when things are going well. If we have a situation where both houses of Congress are split in terms of loyalties, at a time when you have structural problems with the economy, I would conclude that gridlock would not be good." (Reporting by Ross Kerber; Editing by Matthew Lewis and John Wallace)
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