Improved Equity Markets Should Lift Cohen & Steers' AUM, but Rate Headwinds Will Blunt Flows

Strategist

Greggory Warren

A combination of rising interest rates, equity and credit market headwinds, and increased competition from private real estate investment vehicles offered by alternative asset managers and other traditional asset managers has had (and is likely to continue to have) an adverse effect on Cohen & Steers' level of managed assets. The firm closed out the March quarter with $81.2 billion in managed assets, up 1.7% year over year, but still down 22.0% from a peak of $106.6 billion at the end of December 2021. 

Market losses have had a bigger negative impact on assets under management than outflows since the start of 2022, with Cohen & Steers experiencing a 12.0% decline in managed assets due to market-related losses over the past nine calendar quarters. This was better market-related performance than core benchmarks—the FTSE Nareit All REITs TR Index (down 17.6%) and the Morningstar Global Markets REIT TR Index (down 18.6%)—during the same time frame. 

Some of this could be due to diversification of Cohen & Steers' portfolio (with 35% of AUM coming from globally listed infrastructure funds, preferred securities, and other investment vehicles), but overall performance remains solid, with 96% and 97% of total AUM outperforming strategy benchmarks on a three- and five-year basis, respectively, at the end of last year.

Although this level of outperformance would normally boost flows, fixed-income securities, and bond funds are currently offering equivalent or higher yields than REITs, with less risk for investors, which has raised the company's average redemption rate to 25% the past nine calendar quarters (compared with 19% on average during 2017-21) and blunted sales of REIT-based products.

On top of that, competition from private real estate investment vehicles, which are marked to model as opposed to being marked to market like listed REITs, has been stiff—with funds like the Blackstone Real Estate Income Trust, or BREIT, posting annualized returns of positive 11.1% and 10.8% the past three and five years, respectively, at the end of March 2024—as these products have increased their share of the institutional market and made major headwinds in the retail-advised channel.

Business Strategy & Outlook

We believe the asset-management business is conducive to the creation of economic moats, with switching costs and intangible assets being the most durable sources of competitive advantage for firms in the industry. Although the switching costs might not be explicitly large, inertia and the uncertainty of achieving better results by moving from one asset manager to another tend to keep many investors invested with the same funds for extended periods. As a result, money that flows into asset-management firms tends to stay there. For the industry overall, the average narrow redemption (retention) rate, which does not include exchange redemptions, has been 25% or less (75% or greater) annually during the past 5-, 10-, 15-, 20-, 25-, and 30-year time frames. Including exchange redemptions, the rate has been less than 30% (greater than 70%). 

In Cohen & Steers' case, the firm's average annual redemption (retention) rate was 22% (78%) and 20% (80%) during the past 5- and 10-year calendar periods, respectively, comfortably below (above) the industry average. During 2019-23, Cohen & Steers' organic AUM growth rate (inclusive of distributions) averaged positive 5.6% (positive 1.0%) annually with a standard deviation of 7.8% (7.2%), which meant the firm was in most years leveraging its below-average redemption rate to generate positive flows. Results were slightly worse over the past 10 calendar years, with the firm's organic AUM growth rate (inclusive of distributions) averaging 5.1% (negative 1.0%) annually with a standard deviation of 6.6% (6.0%).

While we don't envision much change in Cohen & Steers redemption (retention) rate going forward, given that performance remains solid (relative to strategy benchmarks) and tax considerations create headwinds when retail investors consider selling mutual funds, our current forecast for annual organic AUM growth (when adjusted for distributions) is negative 0.9% (negative 4.7%) during 2024-28, with a standard deviation of 4.9% (4.7%). This is reflective of our expectations for increased competition for listed real estate investment products from private real estate investment vehicles offered by alternative asset managers and other traditional asset managers that have increased their share in both the institutional and retail-advised channels.

Although the barriers to entry are not all that significant for the industry, the barriers to success are extremely high. It takes time and skill to put together a long enough record of investment performance to start gathering assets and build the scale necessary to be competitive. This has meant that the larger, more established asset managers have tended to have an advantage over smaller players, especially when it comes to gaining cost-effective access to distribution platforms. Competition for investor inflows can be stiff and has traditionally centered on investment performance, especially in the retail channel.

Even though institutional investors and retail gatekeepers are exerting pressure on pricing, competition based on price has been rare, aside from what we've seen in the US market for exchange-traded funds. While compensation remains the single-largest expense for most asset managers, supplier power has been manageable, as many firms have reduced their reliance on star managers and have tied manager and analyst pay to both portfolio and overall firm performance. 

Asset stickiness (the degree to which assets remain with a manager over time) tends to be a differentiator between wide- and narrow-moat firms, as those asset managers that have demonstrated an ability to gather and retain investor assets during different market cycles have tended to produce more stable levels of profitability, with returns exceeding their cost of capital for longer periods. While the more broadly diversified asset managers are structurally set up to hold on to assets regardless of market conditions, it has been firms with solid product sets across asset classes (built on repeatable investment processes), charging reasonable fees, and with singular corporate cultures dedicated to a common purpose that have done a better job of gathering and retaining assets. Firms offering niche products with significantly higher switching costs—such as retirement accounts, funds with lockup periods, and tax-managed strategies—have tended to hold on to assets longer. 

Cohen & Steers, in our view, has a narrow economic moat. Although the company does possess some attractive attributes, like a well-respected brand, well-forged distribution ties, and a profitable investment strategy, we have found that firms that are heavily skewed toward one particular asset class or category, as Cohen & Steers is, tend to have a more challenging time generating consistent returns for investors. The company's product mix is heavily tied to REITs, with domestic and global/international real estate securities accounting for close to two thirds of Cohen & Steers' total AUM of $81.2 billion at the end of March 2024. The firm has made some strides toward diversification but has yet to gain the scale necessary in its non-REIT offerings to overcome the somewhat higher level of concentration risk that exists in its portfolio.

The company does garner some credit for its geographic diversification, with 24% (14%) of its AUM (total revenue) coming from outside of the US—with Europe, the Middle East, and Africa accounting for 7% (5%), Japan at 12% (7%), and the rest of the Asia-Pacific region accounting for the remainder. During the past four calendar quarters, the company garnered 42% (27%) of its managed assets (base management fees) from institutional relationships, which tend to be stickier than retail-derived assets. 

Cohen & Steers also generated 13% (21%) of its AUM (base management fees) from closed-end funds, which differ from open-end funds in that they cannot be redeemed back to the fund manager, providing the firm with a greater hold over this portion of its managed assets. While these attributes have provided Cohen & Steers with a slightly higher degree of asset stickiness than most of its peers in stable and rising markets, the concentration risk that continues to exist in its investment portfolio ultimately inhibits the firm from developing more than a narrow economic moat.

Business ethics, product governance, and data privacy and security are some of the larger issues for asset managers when looking at environmental, social, and governance risks. Cohen & Steers, in our view, is at a lower risk of experiencing material financial effects from ESG factors, due to its medium exposure to the risks inherent to the industry, as well as its own operations, offset by the firm's solid management of its ESG issues (the company has experienced only a moderate level of controversies over the years). 

From a business ethics and product governance perspective, failure to provide reliable and trustworthy services can affect both reputation and financial performance, so asset managers like Cohen & Steers tend to be more careful with how they manage the pricing, performance, and positioning of their products. They also spend a lot of time and capital to safeguard against data breaches, which can cause service disruptions, trigger lawsuits and forensic investigations, incur expenses related to repairing or removing threats from data systems, damage reputations, and shake customer confidence. From an asset-management perspective, Cohen & Steers remains committed to integrating ESG across all asset classes and investment strategies to meet the evolving demand for the integration of ESG factors into investment offerings.

Narrow

Economic Moat

Cohen & Steers

Cohen & Steers, Inc. is a holding company which operates as an investment manager specializing in liquid real assets, which include real estate securities, listed infrastructure, commodities, natural resource equities, preferred securities, and other income solutions. It manages investment vehicles, such as institutional accounts, open-end funds and closed-end funds. The company was founded by Martin Cohen and Robert Hamilton Steers in 1986 and is headquartered in New York, NY.

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