Investment income hole hits asset manager profits

BOSTON (Reuters) - U.S. asset managers are learning the painful lesson that what goes around comes around.

These companies enjoyed big boosts to profits in 2007 by investing their own funds, as the stock market rose. But the market tumble in the first quarter of 2008 has forced many to mark down the values of those investments and book the losses, and some to also miss Wall Street earnings estimates.

While the losses may not diminish their appeal as relative safe havens in the financial sector amid the credit crisis, analysts expect earnings of asset managers in the quarters ahead to drop or show more volatility.

"We all didn't gauge that correctly and understand the extent of the volatility," Michael Kim, an analyst at Sandler O'Neill & Partners, said of the drop in investment income.

"That is something we are seeing across all of the asset managers. It certainly adds a layer of incremental volatility in terms of the bottom line," Kim added.

Asset management companies make seed capital investments in mutual funds and hedge funds that they aim to launch eventually. Some also invest in funds alongside their clients' investments to demonstrate that their interests are aligned.

These investments, and investments of cash surpluses generated by the business, had provided healthy nonoperating incomes to companies in the last five years as stock markets were climbing. But the picture changed as the credit crisis hit in mid-2007 and worsened as the market stumbled in early 2008.

Losses from seed capital investments shaved 12 cents of earnings per share from BlackRock Inc (BLK.N) in the first quarter, leading the biggest publicly traded U.S. asset manager to a relatively rare earnings miss. The investments had added 16 cents per share to BlackRock's earnings in the first quarter of 2007.

"We have taken a more cautious approach to modeling investment income going forward given challenging markets," Douglas Sipkin, analyst at Wachovia Capital Markets, wrote in a report on BlackRock.

Sipkin cut estimates for BlackRock's quarterly gross investment income to $15 million from $25 million for the remainder of 2008.

'LESS VISIBILITY'

Calamos Asset Management Inc (CLMS.O) perhaps suffered the most in the first quarter as its quarterly earnings fell 94 percent when it booked a loss of 25 cents a share, mainly due to the market impact on seed capital investments.

Franklin Resources Inc (BEN.N), Janus Capital Group Inc (JNS.N) and Federated Investors Inc (FII.N), too, were hit by the lower investment income.

Investors can better anticipate asset manager earnings from their main business -- managing clients' money for a fee. That is because many companies report asset levels on a monthly basis or give some sense of the asset mix.

But it's relatively difficult to forecast earnings on nonoperating investment income because companies are less forthcoming in giving details of its mix or size.

"Generally speaking you have less visibility into what the components are and what may be the mix in terms of the asset class," said D.J. Neiman, an analyst at William Blair & Co.

"That is what caused some of the negative surprises there," Neiman said, referring to the disappointing quarterly results.

Compared with commercial and investment banks, where lending and securitization-based businesses have led to losses of billions of dollars, asset management is more transparent and less capital intensive. And when markets improve, the value of these investments will be marked up again.

"On a relative basis, just about any place else you go to in the financial sector, the asset management business is very attractive," said Neiman.

(Editing by Gerald E. McCormick)