We recently published a list of The 10 best asset management stocks to buy according to short sellers. In this article, we take a look at how Brookfield Business Corporation (NYSE:BBUC) compares to other asset management stocks.
At the market level, investing can be divided into two categories: active investing and passive investing. Active investing, as the name suggests, is a practical approach in which the investment manager or the ordinary investor regularly evaluates his portfolio to reduce or increase shares depending on the evolution of the individual capital and the general market trend. Passive investing, on the other hand, means that the individual investor or a fund manager buys shares and then holds them with all his might over a long period of time in order to replicate the evolution of a broader stock index, rather than focusing on the merits of individual stocks.
Comparing the two approaches, passive investing requires less focus. Of course, it’s not surprising that this approach has dominated the market for the past few years. Data from Morningstar Financial shows that year-end 2023 was historic for the stock market, as assets held by all passive funds exceeded those held by active funds for the first time. At year-end, passive mutual funds held $13.29 trillion in assets, which was $60 billion more than active funds’ $13.26 trillion in assets. This shift appears to be driven by the tendency of passive funds to outperform active funds over the long term. According to S&P, over 90% of active equity funds underperformed their underlying benchmark over the past two decades.
However, this shift does not seem to affect all active fund categories. Morningstar data adds that there is a stark contrast between active exchange-traded funds (ETFs) and active mutual funds. When analyzing the net inflows into these two categories between 2008 and 2023, it is seen that inflows into the mutual funds increased significantly until 2014, but the trend reversed somewhat after that. In the years between 2015 and 2023, only 2021 was the year with positive inflows into active mutual funds, as about $150 million of funds flowed into them. In all other years, all inflows were negative, with 2022 being the worst year, which saw about $1 billion in outflows. On the other hand, the inflows for the actively managed ETFs were positive in all these years, recording an average growth of 37% in the decade to 2023.
Although passive funds have outperformed active funds in terms of total assets, there are still a number of active funds that have performed well during this turbulent period. The three active fund categories that have delivered robust returns recently are fixed income funds, real estate funds and small-cap funds. Active fixed income funds had a 53% success rate in 2023, and it is real estate funds where active funds really shine. In the decade to 2023, 51% of active real estate funds outperformed their passive counterparts, making them the only funds to do so during this period. Finally, fund managers benefited from their expertise and resources, as 41% of active small-cap funds beat passive funds and their excess returns exceeded 16%.
While the growth in passive funds indicates a democratization of the stock market as these funds are favored by retail investors, it also leads to some undesirable consequences. For example, a 2019 study by the Federal Reserve shows that passive ETFs and mutual funds from the five largest asset managers had $7.7 trillion in assets under management as of December 2019. This represented 47% of all such funds, with Vanguard in particular accounting for 25% of the pie.
Research from Harvard and Columbia provides further insight, particularly regarding the control that the largest asset managers can exert on the stock market. Harvard estimates that the three largest index fund managers, namely BlackRock, Vanguard and State Street, held an average stake of 22% in the companies in the benchmark S&P index in 2021, which corresponds to 25% of the votes cast in these companies. Columbia adds that in 90% of these 500 companies, one of the Big Three is not only a shareholder but also the largest Shareholder.
Another consequence of the shift to passive investing is the impact on the valuation of large-cap stocks. According to Man Group, $2 out of every $3 of large-cap stocks comes from passive investing. As we saw with the artificial intelligence boom, stocks of major technology companies have driven up stock market valuations, and research from the London School of Economics and the University of Michigan provides further details on the growth of passive investing and its impact on the valuation of large-cap stocks. They show “that inflows into passive funds disproportionately increase the share prices of the largest companies in the economy, particularly those large companies that are overvalued by the market,” adding that these inflows “can drive the overall market higher, even when the inflows are entirely due to investors switching from active to passive investments.”
These recent trends have also hit small-cap stocks pretty hard. According to Morningstar’s Dave Sekera, small-cap stocks are “actually trading at about a 20% discount to our fair value, so there’s a lot of value there. So I think once we get past, you know, a lot of the thematic trading that’s really driven the market over the last year and a half, the market will start to become more of a stock picker’s market again, which I think we need to see for the market to continue its gains. But I think stock pickers, especially in the small-cap space, have a long way to go.”
Our methodology
To create our list of the best asset management stocks to buy according to short sellers, we ranked these stocks by their short interest as a percentage of shares outstanding, selecting the stocks with the lowest percentage and a market cap of over $600 million to eliminate the impact of low liquidity.
With these stocks, we also mentioned the number of hedge fund investors. Why do we care about the stocks that hedge funds invest in? The reason is simple: Our research has shown that we can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks each quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (Further details can be found here).
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Brookfield Business Corporation (NYSE:BBUC)
Number of hedge fund investors in Q2 2024: 2
Short Interest % of outstanding shares: 0.43
Brookfield Business Corporation (NYSE:BBUC) is one of the more interesting asset managers because it doesn’t primarily deal in financial instruments like debt and private equity. Instead, the company offers investors the opportunity to invest indirectly in a variety of companies in renewable energy, credit, real estate, private equity, and other sectors. This means Brookfield Business Corporation (NYSE:BBUC)’s business isn’t as vulnerable to interest rate shocks, stock market declines, or M&A slowdowns as traditional asset managers. The diversified business also insulates the company from a downturn in a single industry because Brookfield Business Corporation (NYSE:BBUC) can draw on a number of companies to generate operating profits. This also means the company can generate large amounts of cash by selling its businesses when it sees fit, as it did when it sold its Westinghouse stake for a whopping $8.2 billion in 2023 after acquiring the company for $4.6 billion in 2018. Brookfield Business Corporation’s (NYSE:BBUC) relationship with Brookfield Asset Management and affiliates also provides the company with a financial buffer and key partners, as the sale of Westinghouse was to another Brookfield company.
Brookfield Business Corporation (NYSE:BBUC) presented some of the deals it has completed in recent years during its second quarter 2024 conference call:
“To date, we have sold or entered into agreements to sell 10 companies in the last 1.5 years for approximately $3 billion in aggregate proceeds to our equity. Most of the proceeds we have generated have come from buying good companies on a value basis, improving their operations and repurposing capital to support our growth. In some cases, we can do this in a relatively short period of time. In other cases, holding a company longer may be the best way to continue to grow value. Many of our companies generate stable cash flows. And in some cases, we may also be able to prudently increase debt to fund distributions. Regardless of when we decide to monetize a company, our goal is to maximize value. We have built an excellent track record as a public company, achieving 3x MoC at 30% IRR when selling 20 companies.
Today, we own great businesses and continue to drive value as we advance our improvement plans. This should create opportunities for us to generate meaningful returns in our next monetization phase.”
Total BBUC 9th place on our list of the best asset management stocks to buy according to short sellers. While we recognize BBUC’s potential as an investment, we believe AI stocks promise higher returns and do so in a shorter time frame. If you’re looking for an AI stock that’s more promising than BBUC but trades at less than 5x earnings, read our report on the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey.
