By Sam Mamudi

Analysts covering the asset-management sector have been revising earnings estimates to reflect an improved outlook for money managers.

But while the picture is rosier, first-quarter results for the industry are expected to be poor, and perhaps even worse than the fourth quarter, which was one of the worst on record.

"I think we'll see lower results in the first quarter," said Matthew Albrecht, an analyst at Standard & Poor's. "From an operational perspective, management fees are based on asset balances, and those will be even lower."

"We expect the group's assets under management to decline 9% on average with a continued negative mix shift (away from equities) and further operating margin contractions," added Marc Irizarry, Goldman Sachs analyst, in a research note.

Albrecht said that the lower proportion of fees from stock funds, which charge the highest fees, will hurt management firms.

But there may be a bright spot. Albrecht said that if asset managers' write-downs from their own investments are less than they were in the fourth quarter, the latest quarter results may be slightly better.

"Marks on balance sheet investments will continue to be a drag, albeit not bad as in fourth quarter," Irizarry wrote.

Some analysts also see further belt-tightening at asset managers.

"Despite the recent market run-up, we continue to expect that managers will cut expenses, especially compensation," said Ken Worthington, an analyst at J.P. Morgan.

But Worthington does see some reason for optimism.

"While 2009 will still likely be a challenged year, if a recovery does materialize, we now expect a somewhat more normalized earnings stream in 2010," he wrote.

Changing Estimates

Worthington and Craig Siegenthaler, an analyst at Credit Suisse, both raised estimates for T. Rowe Price Group (TROW) and Franklin Resources Inc. (BEN), while Siegenthaler and Irizarry raised estimates for Invesco Ltd. (IVZ).

Siegenthaler also raised estimates for Janus Capital Group (JNS), but Irizarry cut estimates for the firm.

Siegenthaler and Irizarry cut estimates for Federated Investors Inc. (FII). Siegenthaler said Federated had negative money-market fund flows in February and March. He rates the stock as "underperform."

Worthington rates Federated as "neutral," but added, "We expect that if equity markets improve, Federated would underperform peers due to a lower percentage exposure to equity funds."

One asset manager on which there was broad agreement was Legg Mason Inc. (LM).

Goldman Sachs, Jefferies & Co., Credit Suisse and FBR Capital Markets all raised 2010 earnings estimates for the firm. Jefferies rates the stock as a "buy"; Credit Suisse and FBR rate it "underperform."

Siegenthaler, however, noted that Legg Mason had the strongest improvement in relative fund performance among fund managers in March. Fifty percent of its mutual-fund assets are in funds ranked four and five stars by investment researcher Morningstar Inc. over a three-year period, he said.

On Wednesday, Legg Mason said it had amended debt covenants, paid down $250 million in debt and sold its last exposure to special investment vehicle debt. While its stock was up about 11% Thursday on the news, analysts said the higher estimates were due to improved market conditions.

But Hojoon Lee, an analyst at Morgan Stanley, was cautious. "Legg Mason may not benefit [from stronger flows] because of performance issues in both its fixed-income and equity funds," Lee wrote.

Despite the growing enthusiasm for asset managers, there is a sense among some analysts that improved market conditions - the S&P 500 Index (SPX) jumped 18% from March 6, when it closed at 683, to the end of the quarter - may have led to a false sense of optimism.

"In our view, asset managers' valuations over-anticipate a sustained market rally ahead of another tough earnings period - albeit one that is "less worse" than the fourth quarter of 2008," Goldman's Irizzary noted.

-By Sam Mamudi, 415-439-6400; AskNewswires@dowjones.com