Asset managers: One simple metric to consider before buying

A good friend of mine recently told me he's looking to buy some shares in Platinum Asset Management Limited (ASX: PTM) and I wondered to myself if this is the best possible use of his money. I didn't really know so I thought I'd research how this business has grown and whether we can expect more of the same in the future.

I then thought more generally about asset managers and decided to bring BT Investment Management Ltd (ASX: BTT) and Magellan Financial Group Ltd (ASX: MFG) into the equation to see how each has performed in absolute terms and in relation to each other.

All of these companies have strong balance sheets and very high levels of profitability as evidenced by each company's return-on-equity (ROE) figures for the 2015-16 financial year.

However, to judge whether the shares of the business in question are a good investment, I like to see a history of growing funds under management (FUM). After all, the money they're managing is the lifeblood of any funds manager and without a growing pile of cash to manage each year, there'd be no prospects for growth otherwise.

I thought I'd demonstrate that here with data back to the 2007-08 financial year when BT Investment Management first became a listed entity after it was spun out of Westpac Banking Corp (ASX: WBC) in late 2007. Here's a history of each company's FUM since 2007-08:

Funds under management ($b)

Source: Annual reports

* compound annual growth rate

It's also important to acknowledge that each of these businesses will be managing varying proportions of retail and institutional money. Generally, institutional money mandates will be larger but come with lower margins than money managed for individual investors who not only pay more but tend to stick around a lot longer.

With that caveat out of the way, here are the growth figures (CAGR) for each company's EPS and investment return since 1 July 2007:

Platinum

BT Investment Management

Magellan Financial Group

^ since 2009-10

** calculated from 1 July 2009

Foolish takeaway

I was somewhat surprised to see that Platinum's growth in FUM has been so anaemic (it's even worse if you consider that the 2006-07 figures were $21.2b with growth in FUM over the 10 years to 2015-16 only 0.64%).

When looking at the above figures, it's no surprise that each company's level of growth in FUM, EPS and investment return are not dissimilar to each other.

I therefore believe that if you're going to buy shares in an asset management business, the first thing you need to do is determine how well each company is placed to grow their FUM in the future. Will it be by acquisition or will they rely on investment returns, or both?

The second most important thing then is to form an opinion on whether or not you think that past performance in growth of FUM will continue.

Will Platinum's low growth rates remain, or will there be a step-change? If so, what's the catalyst for this to occur?

Can you expect Magellan's high growth rates in FUM to continue, or will these moderate?

If you can answer these questions, then you may have worked out whether buying shares in any of these businesses will align with your overall investment strategy and, in short, whether these stocks' future returns will meet your expectations.