Asset management firm Westwood Holdings has dramatically underperformed its peers over most relevant periods due to growing outflows, high shareholder discontent, and an overtenured board.

As a result, management’s failing growth strategy is poised to be tested. Westwood is in the 99th percentile of companies most vulnerable to activism over the next nine months, according to Activist Insight Vulnerability.

The company’s next annual meeting takes place on April 28, and any further discontent against directors could pave the way for an activist campaign.

Activist thesis

Given the growing competition from passive asset managers like BlackRock and Vanguard and ongoing consolidation in the active asset management sector, an activist investor could demand a sale to stop further destruction of shareholder value. An activist could also ask for quick steps to arrest outflows, including aggressive scouting for investment talent and ramp-up of marketing expenses.

Other obvious demands could be a board refreshment, an amendment in executive compensation, and management change, as shareholder discontent surged dramatically at the 2020 annual meeting in April.

Business structure

Westwood Holdings Group is a $130-million asset management firm located in Dallas, Texas. It provides investment management and wealth management services, under a series of products, including mutual funds, institutional strategies, and separately managed accounts. Westwood Alternative Income Fund and Westwood Quality Value Fund are among the mutual funds it manages.

Westwood earns money by charging fees to its assets under management, which at the end of 2020 stood at around $13 billion. Its customers include pension funds, foundations, and endowments, as well as financial intermediaries and high net worth individuals.

Financials

Westwood’s financials have suffered over the past five years, as the company failed to stem net outflows. Revenues have declined from $123 million in 2016 to just $65 million in 2020. Assets under management fell from $21.2 billion in 2016 to $13 billion in 2020. The company switched to an Ebitda loss of nearly $5 million in 2020 from a gain of $12 million in 2019. In 2016, Westwood’s Ebitda stood at $37 million.

While the entire asset management industry has suffered from the advent of passive index funds like BlackRock and Vanguard, Westwood has been among the worst losers. An activist could demand whether there is something the company could do to stem outflows and start growing assets under management again.

Peers and industry

The rise of cheap passive index funds like BlackRock and Vanguard has put immense strain on active investment fund managers. The smaller, non-diversified ones like Westwood have suffered in particular, as investors moved their money into index-following products.

Activist investor Trian Partners thinks traditional asset managers should consolidate to save on costs and better compete with index funds. Trian has so far contributed to the merger of Legg Mason and Franklin Templeton and is now pushing Janus Henderson to merge with Invesco.

Given the industry challenges, an activist could also push Westwood to put itself up for sale or merge with other peers.

Valuation and performance

Westwood’s performance has been very weak. According to Activist Insight Vulnerability, Westwood’s five-year total shareholder return (TSR) is negative 55.3%, compared with 37.6% for the median peer. Its one-year TSR is negative 15.6%, while the median peer returned 67.8%.

The company’s valuation has also suffered. Westwood trades at a price-to-book ratio of 0.91, versus 2.03 for the median peer, according to Activist Insight Vulnerability.

Corporate governance and management

A board refreshment at Westwood is long overdue. According to Activist Insight Governance, the board’s average tenure is 15.3 years versus 8.2 years for the S&P 500 average. Three of the six directors have served for 19 years on the board.

Due to lack of board refreshment, shareholder discontent is very high. According to Activist Insight Vulnerability, four directors received 37% or more of ‘against’ votes on their re-election last year in April. Raymond Wooldridge, an 82-year old who has served for 19 years, got 41% of votes against his re-election.

Meanwhile, more than 36% of shareholders voted against executive compensation, with some investors motivating their decision by saying performance metrics are not clearly defined, according to Proxy Insight Online.

Westwood does not have a majority standard in uncontested elections, making a potential withhold campaign difficult. It also does not provide any shareholder right to act off-season.

Shareholder register

Westwood’s shareholder register is filled with typically active stock pickers that are more likely to side with activists than passive managers like State Street and BlackRock. According to Activist Insight Vulnerability, occasional activists Gamco Investors and Osmium Partners own 6.9% and 2.3% of the shares, respectively, while D.E. Shaw has 0.7%. Gamco sided with activists in 56% of the times in the last 67 proxy contests, according to Proxy Insight Online.

At the 2020 annual meeting, even passive investors Vanguard, which owns over 6% of the stock, and State Street, which owns 1.8%, voted either against or withhold most directors and executive compensation.