WDR Initiation

INITIATION | COMMENTJULY 24, 2012

Waddell & Reed Financial, Inc. (NYSE: WDR)

Performance - Could be a Cure-All

Sector PerformAverage RiskPrice: 27.63

Shares O/S (MM): 86.3Dividend: 0.90

Price Target: 30.00Implied All-In Return: 12%Market Cap (MM): 2,384Yield: 3.3%

Priced as of market close, July 24, 2012 ET.

Investment Conclusion

While we are seeing encouraging signs such as a decline in outflows at thecompany’s flag ship Ivy Asset Strategy fund and strong inflows into fixed incomeproducts, we believe the shares are fairly valued.

We believe there is limited upside potential based on the following:

• Recent performance has been weak: While Waddell & Reed has anexceptionally strong five-year performance track record with 77% of its equityfunds in the top quartile, the three-year and one-year performance has not beenstrong. Only 18% of the company’s funds are in the top quartile on a three-yearbasis and just 11% are in the top quartile on a one-year basis.

• The two largest equity funds are still in outflow mode: Performance at IvyAsset Strategy, WDR's largest equity fund, is deteriorating. The company'ssecond largest equity fund, the Ivy Global Natural Resources fund, ranks in thebottom 10 percent in terms of performance.

• Increased sales through the wholesale channel could lead to increasedredemptions if performance does not improve: Redemption rates continue tobe above average for the Wholesale channel, its fastest growing distributionchannel. We believe that performance is more important to competesuccessfully in this channel than in the Advisory channel, which has had lowredemption rates.

• Changed consumer behaviour could pose headwinds: The financial crisishas changed the way consumers think about saving and investing. This is truefor the company's main client base, the middle income, mass affluent andgeneration-Y clients. Frugality combined with a push to increase disclosuresaround expenses could lead to a bifurcation, with top active managers orcheaper ETFs getting the bulk of fund flow.

• Macro environment not a tailwind: We believe having over 80% of assets inequity funds is a disadvantage. With no clear direction for the economy andconsumer confidence remaining low, we would expect further redemptions inequities and inflows into fixed income funds. .

We value WDR using a 7% discount to average peer 2013 P/E multiple. Webelieve this is justified given the large exposure to equities and recent fundperformance.

Priced as of prior trading day's market close, EST (unless otherwise noted).

125 WEEKS 12MAR10 - 23JUL12

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M A M J J A S O N2010

D J F M A M J J A S O N2011

D J F M A M J J2012

HI-08APR11 42.49LO/HI DIFF 97.44%

CLOSE 27.84

LO-02JUL10 21.52

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PEAK VOL. 11107.8VOLUME 393.1

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Rel. S&P 500 HI-23APR10 106.58HI/LO DIFF -38.22%

CLOSE 68.91

LO-30DEC11 65.84

RBC Capital Markets, LLC

Bulent Ozcan, CFA (Associate Analyst)(212) 863-4818; [email protected]

Eric N. Berg, CPA, CFA (Analyst)(212) 618-7593; [email protected]

Kenneth S. Lee (Associate)(212) 905-5995; [email protected]

FY Dec 2010A 2011A 2012E 2013E

Adj EPS - FD 1.83 2.05 2.24 2.59

Net Flows (B) 5.4 5.0 3.5 5.2

AUM (B) 83.7 83.2 97.6 109.6

P/AEPS 15.1x 13.5x 12.3x 10.7x

Adj EPS - FD Q1 Q2 Q3 Q4

2010 0.42A 0.40A 0.47A 0.54A

2011 0.53A 0.58A 0.46A 0.47A

2012 0.55A 0.55E 0.56E 0.57E

2013 0.61E 0.64E 0.67E 0.67ENet Flows (B)

2010 2.8A 0.7A 0.7A 1.2A

2011 1.9A 1.7A 1.3A 0.0A

2012 1.3A 0.6E 0.8E 0.8E

2013 1.2E 1.3E 1.3E 1.4EAUM (B)

2010 74.2A 68.3A 76.0A 83.7A

2011 90.1A 91.7A 77.5A 83.2A

2012 93.8A 91.9E 95.2E 97.6E

2013 100.4E 103.4E 106.4E 109.6E

All values in USD unless otherwise noted.

For Required Non-U.S. Analyst and Conflicts Disclosures, see page 36.

2

Investment Summary

We are initiating coverage of Waddell & Reed with a Sector Perform, Average Risk rating and a $30 price

target. We view the following favourably:

Equity fund outflows have declined significantly over the previous quarter. Waddell & Reed reported

outflows of $1 billion from its equity funds in the December quarter. As of March 31, 2012, outflows

had declined to $71 million. Outflows were only a fraction of what the industry experience had been (as

a percentage of beginning account values). We project positive flows for the second quarter of 2012.

Waddell & Reed has generated very strong organic growth in its fixed income franchise. Fixed income

funds are just a small part of its business. However, we like the fact that the company seems to be able

to appeal to fixed income investors, offsetting equities outflows experienced over the past two quarters.

Waddell & Reed has very strong long-term fund performance as measured over a five-year period.

Based on Lipper, 77% of its equity funds have ranked in the top quartile of their respective peer groups

and 88% have ranked in the top half. These are impressive results.

There are initiatives underway which could help Waddell & Reed attract additional assets. It is

deepening its relationships with independent distributors and regional broker/dealers such as LPL and

Edward Jones. Management stated that WDR is in a nascent state with some of the largest distributors. It

is using hybrid wholesalers to increase market share. There is potential to grow assets.

However, there are challenges the company faces which lead us to believe that the shares are fully priced at

current levels:

Short term performance has been weak. While Waddell & Reed has an exceptionally strong five-year

performance track record, the three-year and one-year performance have not been strong. Only 18% of

the company’s equity funds are in the top quartile on a three-year basis and just 11% are in the top

quartile on a one-year basis.

WDR’s two largest equity funds are still in outflow mode. Performance at Ivy Asset Strategy is

deteriorating, based on the latest Morningstar data. WDR’s second largest equity fund, the Ivy Global

Natural Resources fund continues to generate inadequate performance, with 90% of its peers

outperforming the fund.

Redemption rates continue to be above average for the Wholesale channel, WDR’s fastest growing

distribution channel. We believe that performance is becoming increasingly important to retaining and

growing assets in this channel. The company’s “captive” sales force (Advisory channel) has had low

redemption rates, in comparison. We think there is little loyalty in the Wholesale channel as advisors

chase performance.

We believe that a change in consumer behaviour could pose headwinds for the company on two fronts.

The financial crisis has impacted its core customer base, the middle income and mass affluent, more

than that of its competitors. Having seen their wealth dissipate, we believe these customers have become

more cost conscious and are in need of strong performance. ETFs are a cheaper option if performance

lags. The company’s upcoming customer base, generation Y, has fewer resources than previous

generations and is more technologically savvy. They might rely less on brokers and advisors and choose

instead to buy directly. One way WDR could differentiate itself would be to through strong

performance.

Given the state of the economy and investor sentiment, having over 80% of assets tied to equity funds

could be a disadvantage. With consumer confidence remaining low, economic growth declining globally

and Europe working very slowly through its issues, equity funds could see an increase in redemption

requests.

Waddell & Reed Financial, Inc.July 24, 2012

3

Company Overview

Waddell & Reed, Inc., founded in 1937, is one of the oldest mutual fund companies in the United States,

having introduced the Waddell & Reed Advisors Group of Mutual Funds in 1940. Waddell & Reed

Financial, Inc. provides investment advisory, distribution and administrative services. It operates its

business through three distinct distribution channels: Advisors channel, Wholesale channel and Institutional

channel. The Advisors channel focuses on financial planning, serving primarily middle class and mass

affluent clients. The Wholesale channel's activities include retail fund distribution through broker/dealers,

registered investment advisors and retirement and insurance platforms. The Institutional channel manages

assets in a variety of investment styles for a variety of types of institutions.

Exhibit 1: Waddell & Reed Snapshot

Waddell & Reed

Headquarters Overland Park, KS

Total AUM $93.8 bn

Major Brands Ivy Funds, Waddell & Reed

% retail funds AUM rated 4-5

stars by Morningstar13%

Signature Active investment manager with captive sales force

Source: Company filings; RBC Capital Markets

Valuation

The asset managers are currently trading at 12.3x calendar-year 2013 estimated earnings. Over the past 10

years, Waddell & Reed has been trading at a 7% discount to peers. We believe that the discount is still

justified given the company’s large exposure to equity funds and the weak performance of its two largest

funds. We arrive at our price target using a price-to-earnings multiple of 11.4x, which represents a 7%

discount to the company’s peers and our 2013 calendar year earnings estimate of $2.59 per share. Our price

target is $30.

Exhibit 2: WDR’s Forward Looking P/E Relative to RBC Asset Managers Index

0.3x

0.4x

0.5x

0.6x

0.7x

0.8x

0.9x

1.0x

1.1x

1.2x

1.3x

Jan-0

7

Jul-

07

Jan-0

8

Jul-

08

Jan-0

9

Jul-

09

Jan-1

0

Jul-

10

Jan-1

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Jul-

11

Jan-1

2

Jul-

12

Note: RBC Asset Managers Index includes BLK, EV, IVZ, LM, TROW, WDR, BEN, JNS, AB, ART, AMG, CNS, CLMS, GBL, PZN

Source: Bloomberg; RBC Capital Markets


4

Ownership

Exhibit 3: Top 10 Holders

Position Mkt Val

Ultimate Holder ('000) (MM) % OS

FMR LLC 7,073 208 8.2

BlackRock, Inc. 4,330 127 5.0

The Vanguard Group, Inc. 4,120 121 4.8

Wellington Management Co. LLP 3,536 104 4.1

Atlanta Life Financial Group 3,041 89 3.5

Kornitzer Capital Management, Inc. 3,016 89 3.5

Affiliated Managers Group, Inc. 2,760 81 3.2

Fisher Asset Management LLC 2,611 77 3.0

Legg Mason, Inc. 2,347 69 2.7

State Street Corp. 2,000 59 2.3

Source: FactSet

Exhibit 4: Ownership by Region

Position Mkt Val

Global Region ('000) (MM) % OS

North America 73,243 2,155 84.8

Europe 2,734 80 3.2

Pacific 47 1 0.1

Asia 4 0 0.0

Middle East 4 0 0.0

Source: FactSet


5

Investment Thesis & Analysis

We are initiating coverage on Waddell & Reed with a Sector Perform, Average risk rating. We believe that

strong past performance and a dedicated “captive” sales force helped the company navigate through the

financial crisis – despite the company’s large exposure to equity funds and the recent performance of its

funds. Yet, we see limited upside potential for the shares as we believe there are obstacle the company need

to overcome, with the largest being fund performance.

At the same time, one cannot be overly pessimistic about Waddell & Reed’s prospects. For the purpose of

this initiation note, we have focused on areas for improvement instead of weighing the positive against the

negatives. We believe the Investment Summary provides a balanced overview in a succinct way. Assuming

that investors are familiar with the Waddell & Reed story, we instead focus on variables we use to measure

the company. These could influence our thinking about the company in the future. We discuss our concerns

in detail below:

Recent Performance Lags Peers

In our opinion, the biggest issue the company faces is performance. Recent performance has not been strong and absent an improvement, assets under management could decrease due to outflows.

We would like to acknowledge that Waddell & Reed funds have had an immensely strong track record.

Consider this: About 77% of its equity funds are ranked by Lipper in the top quartile for a five-year period.

Furthermore, the company’s funds have held top spots in Barron’s “Best Mutual Fund Families” rankings,

with Ivy Funds being the top performer for two years in a row. This is encouraging to us.

Exhibit 5: Barron’s Five-year Performance Rankings

Year Ended Waddell & Reed Ivy Funds

2011 (53 firms) 2 1

2010 (54 firms) 2 1

2009 (54 firms) 1 2

2008 (53 firms) 1 3

Source: Company Web site, Barron’s

However, the saying goes that past performance is not a guarantee of future results; and we think Waddell

& Reed is no exception to this rule. Our concern is that recent weak recent performance, coupled with a

change in the behaviour of its client base, could ultimately lead to a structural break. Waddell & Read has

enjoyed the benefits of low redemption rates due to the fact that its client base preferred to purchase funds

through the captive Advisor channel. These advisors preferred to sell WDR funds and keep the assets with

the company. This was not problematic in the past because fund performance had been good.

We believe that it might not be appropriate to operate on the assumption that retention levels will always

remain strong. We may be moving into a period where Waddell & Reed’s organic AUM growth rate could

converge with the industry’s. Exhibit 6 depicts this trend. It shows that over the past three years, the

organic (annualized) growth rate of WDR’s equity fund franchise has started to converge with the industry

growth rate.


6

Exhibit 6: Recent Annualized Organic Growth Resembles that of the Industry

(10%)

(5%)

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US Domiciled Funds Waddell & Reed

Source: Company reports, Morningstar, RBC Capital Markets

We will discuss in greater detail as to why this might have happened in the section titles “Wholesale

Channel Generates Sales, but Retaining Assets could be a Problem”. We believe that weak fund

performance over the past 3 years is one of the biggest contributors to this trend. More recent results have

trailed its peers.

We assessed performance at Waddell & Reed, focusing on the company’s top 10 funds. Our reasoning is

that the largest funds and their respective performance should have the largest impact on organic growth

and on earnings. Our findings based on our analysis: Performance has been not only mediocre for the most

part, but the company has seen increased performance volatility. Although the fixed income funds seem to

be gaining traction, we don’t see the same progress for the equities offering.

This is how we got there: Using Morningstar Direct, we downloaded data for all funds offered and split the

universe into two categories: equity funds and fixed income funds. We then eliminated ETFs, indexed

funds, alternative funds, commodities funds, money market, and funds which invest in properties only. We

eliminated funds which are part of an insurance product offering, as the asset management company has

little control over the ultimate cost structure of the variable annuity or the variable life product being

offered.

We then weighted the rankings of the funds versus their peers using the individual rankings of the

underlying share classes offered within the top 10 funds by their net asset value. That is, we weighted the

rankings by the size of the share class within the subgroup of 10 funds. The exhibits below plot the ranking

for the one-, three- and five-year periods. Understanding that investors and consultants/advisors are focused

on three- and five-year performance, we felt it was important to look at the one-year performance, as it can

serve as an indication of where the three- and five-year performance may head.

While the five-year performance was good – as we would have expected based on the awards the company

has received for its Ivy and Waddell & Reed funds – we are concerned about recent performance.

Specifically, the top 10 equity funds underperformed on a one- and three-year basis. This is a concern since

Waddell & Reed is known for its equity funds, with over 80% of assets under management in this asset

class.


7

Exhibit 7: One-year Performance of the top 10 Funds

0%

10%

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40%

50%

60%

70%

80%

90%

100%

M ay-03 M ay-04 M ay-05 M ay-06 M ay-07 M ay-08 M ay-09 M ay-10 M ay-11

Equities Fixed Income 50 Percentile

Source: Morningstar, RBC Capital Markets

Although Waddell & Reed’s funds were performing well at the onset of the financial crisis, beating the

majority of their peers, performance deteriorated relatively quickly in mid-2009. At one point, over 80% of

their peers were outperforming WDR’s top 10 equity funds, on average. The main culprits were the Asset

Strategy and Global Natural Resources funds, which we cover in more detail later in this note. Despite a

promising early 2011, later results were weak – and the most recent trend is not encouraging either. While

there has been an improvement in the performance of fixed income funds, equity funds continue to be

mediocre.

Exhibit 8: Three-year Performance of the top 10 Funds

0%

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100%

May-03 May-04 May-05 May-06 May-07 May-08 May-09 May-10 May-11



Our concern is that the three-year performance could remain below its peers unless the one-year performance

improves. Given the volatility in performance on a one-year basis, it is difficult to get a sense of where

performance on a three-year basis is heading. What we know is that on an asset-weighted basis, April 2012

figures show that, on average, the top 10 equity funds underperformed more than 70% of their peers. Both

fixed income and equity funds are lagging the majority of their peers. If performance does not improve, we

would expect this trend to impact the five-year numbers as better performance numbers roll off.

Good

Bad

Good

Bad


8

Exhibit 9: Five-year Performance of the top 10 Funds

0%

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100%




On a five-year basis, Waddell & Reed benefits from the strength of previous years. Equity funds are

outperforming 80% of their peers while fixed income funds are easily outperforming three-quarters of their

peers. However, it is just a question of time until more recent three-year numbers roll into the five-year

figures, diluting previous accomplishments. This could impact future sales and flows, unless we see

meaningful progress.

Could we have arrived at a different conclusion if we looked at a larger subset instead of the top 10 funds?

We don’t believe so. Exhibit 10 shows the percentage of retail funds with a four- or five-star rating based

on Morningstar data. The subset is composed of retail open-end funds excluding ETFs and index funds.

The results appear consistent with our previous analysis.

Exhibit 10: Percentage of Retail Funds with Four- or Five-Star Morningstar Ratings

0%

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We believe that improved performance in the company’s fixed income funds is of lesser importance as they

comprise less than 20% of total assets under management. Fixed income funds simply don’t have the same

impact on earnings as equity funds.

Good

Bad


9

Waddell & Reed’s Largest Equity Funds are Still in Outflow Mode

Positive flows into smaller, more successful funds could be more than offset by the outflows from Waddell & Reed’s two largest equity funds. Absent a market rally, growing equity fund AUM could be a challenge.

We believe we could see continued outflows from Waddell & Reed’s largest equity funds, based on the

one-year performance numbers we obtained using Morningstar. Once again, performance at Ivy Asset

Strategy, Waddell & Reed’s largest equity fund with $33 billion in combined AUM, has deteriorated. This

is important as the fund comprises about 35% of total assets under management. Performance had been

improving in early 2012, with Ivy Asset Strategy and Waddell & Reed Asset Strategy in the top 50%

percentile of Morningstar’s one-year ranking in the March quarter. However, recent results show that

management could not hang on to the performance. As of May 2012, the fund was ranking in the bottom

30%.

Exhibit 11: Outflows at Ivy Asset Strategy Accelerating Once Again

($1,000m)

($500m)

$0

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The deteriorating trend continued into June with the fund ranking in the bottom 20% of its peers, according

to Morningstar.

A comment analysts hear frequently is that underperformance is based on certain styles doing better during

certain economic cycles. We have looked at the one-year performance of the Asset Strategy fund and

compared it against the S&P 500 to see if there was a trend we could identify in macro events which could

explain the fund’s performance.


10

Exhibit 12: Ranking of Ivy Asset Strategy Fund and Level of S&P 500

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S&P 5

00

Ivy Asset Strategy Ranking (LHS) S&P 500 (RHS)


We could not identify a correlation between the two, which in our view points to the fund’s performance

being primarily driven by stock selection and not by economic cycles. This makes sense to us. The Asset

Strategy fund can invest in various asset classes, short stocks and use derivatives. Managers can use hedges

to protect against downturns. Therefore, we believe performance is dependent on the portfolio manager’s

ability to choose winners.

As for the Ivy Global Natural Resources fund, Waddell & Reed’s second largest equity fund with almost $4

billion in AUM, performance remains in the bottom 10%. The company announced during the most recent

earnings call that the Global Natural Resources fund had been removed from a model portfolio at a broker-

dealer, with performance being cited as the reason. We think this could lead to further outflows. We

compared the trend in ranking of the Ivy Global Natural Resources fund based on one-year performance

and the trend in the S&P 500 and came to a similar conclusion. There seems to be little correlation between

the ranking of the fund and the broader market. The culprit in the underperformance appears to us to be

stock selection, again.

Exhibit 13: Ranking of Ivy Global Natural Resources Fund and Level of S&P 500

0

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Ivy Global Natural Resources (LHS) S&P 500 (RHS)


Good

Bad

Good

Bad


11

Exhibit 14 indicates the outflows of the Ivy Global Natural Resources fund. We believe that unless

performance improves, we would not expect any major improvements in flows.

Exhibit 14: Outflows at Ivy Global Natural Resources Fund Remains High

($400m)

($300m)

($200m)

($100m)

$0

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Thus, we would expect continued outflows out of the company’s largest equity funds as we do not see an

improvement in performance. This, in turn, will hold back growth of assets under management and

earnings.

Wholesale Channel Generates Sales, but Retaining Assets could be a Problem

With the Wholesale channel sales more prominently impacting total assets under management, we believe that redemption rates could increase. Furthermore, strong fund

performance should become imperative in retaining assets.

We believe that performance could become even more important in the future, as more sales are being

generated by the Wholesale channel.

As management has indicated, redemption rates continue to be above industry average for the Wholesale

channel, Waddell & Reed’s fastest growing distribution channel. The Wholesale channel serves clients

through all the major wire houses, regional and independent broker/dealers. It distributes its retail funds

through registered broker/dealers, investment advisors and retirement and insurance platforms in the

Wholesale channel. These distributors could be less loyal to certain fund families and more focused on

selling the hottest and best performing funds. With the advent of no load retail funds, the cost of switching

funds has been minimized for investors as well as advisors

This is in stark contrast to the Advisor channel, which comprises Waddell & Reed’s “independent financial

advisors”. It enjoys one of the lowest redemption rates in the industry, according to the company. The

Advisor channel provides financial planning services to middle income and mass affluent clients. While

there is an open-architecture environment, advisors sell predominantly Waddell & Reed products and join

the company right out of college or are career changers who have a vested interest in Waddell & Reed

doing well (equity compensation is a part of the company’s strategy to retain the most productive agents).

The wash rate is high with only 30% of applicants becoming careers advisors. However, if applicants

“make the cut”, they are offered extensive support, which builds loyalty. Advisors are managed by eight

regional vice presidents, about 100 managing principals and more than 100 district managers. Thus, while

remaining independent, advisors are still influenced by corporate headquarters. Management said that

assets remain much longer on their books than for competitors who do not have a network of financial

advisors selling their product. We believe the company’s asset retention could be two to three times longer

than competitors’.


12

The importance of the Wholesale channel has increased in recent years. While about 37% of assets under

management were attributed to the Wholesale channel as of the beginning of 2009, about 50% of assets

were raised by the Wholesale channel as of the first quarter of 2012.

Exhibit 15: Wholesale Channel Dominates Sales

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Wholesale Channel Advisory Channel Institutional Channel

Source: Company reports, RBC Capital Markets

In 2003, Waddell & Reed had six wholesalers. Today, it has more than 50 wholesalers and it wants to

expand. As management put it, it has been late to the Wholesale channel, with other tier 1 firms having sold

through the Wholesale channel for much longer. We believe that there are advantages to being late to this

channel as demonstrated by the high redemption rates. We believe that performance could be even more

important to compete in the Wholesale channel compared to the Advisor channel. Exhibit 16 compares

redemption rates across various distribution channels.

Exhibit 16: Redemption Rates by Distribution Channel

0%

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Advisors Wholesale Institutional



13

While Waddell & Reed is broadening its distribution, in a sense, we think it is also reducing the quality of

the assets it is attracting. We believe that a decline in asset retention rates could be a direct result of

increased sales through the Wholesale channel. We believe that the spikes in redemptions seen over the

past three quarter in the Wholesale channel could be the result of weak fund performance.

Changing Demographics and Consumer Behaviour Could Present Headwinds

With the core customer base (the middle income and mass affluent) becoming more cost conscious and the upcoming customer base (generation Y) relying less on guidance by

advisors, benefits of having a captive sales force could evaporate. Outflows could increase.

Waddell & Reed prides itself on providing financial planning to the middle income and mass affluent

market. We believe that the financial crisis has impacted Americans as they have seen a decline in real and

perceived wealth. In a sense, individuals who would have considered themselves “mass affluent” just five

years ago are now most likely considering themselves middle income. We believe that recent changes in

consumer behavior coupled with changes in demographics could lead to higher redemption rates at

Waddell & Reed.

The financial crisis has changed the way investors think about saving and investing. Risk aversion has

increased, especially in the middle income market, which comprises over 80% of Waddell & Reeds assets

under management. Financial concerns have risen as perceived wealth declined among the middle income

and mass affluent clients. The 2012 Merrill Edge Report, which investigates the financial priorities and

concerns of the mass affluent market, identifies rising health care costs and not outliving retirement assets

as the top two financial concerns of the mass affluent.

Exhibit 17: Greatest Financial Concerns of Mass Affluent

73%

72%

74%

70%

52%

89%

83%

80%

80%

61%

45%

83%

N/A

46%

45%

75%

49%

49%

0% 20% 40% 60% 80% 100%

Rising health care costs

Outliving retirement assets

Affording the lifestyle I want in retirement

Impact of the economy

Impact of tax reform

Financially supporting my family, including my

parents or adult children

Current amount of personal debt

Caring for an aging parent and/or adult

children

Rising cost of college

Nov. 11 Apr. 12

Source: April 2012 Merrill Edge Report

Asking the same set of questions of the subgroup generation Y (defined as people between the ages of 18

and 34 in the Merrill Edge Report), Waddell & Reed’s upcoming client base, outliving retirement assets is

an even bigger concern than for the overall mass affluent group.


14

Exhibit 18: Greatest Financial Concerns of Generation Y

70%

66%

69%

93%

92%

92%

89%

N/A

61%

84%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100

%

Outliving retirement assets

Financially supporting my family, including my

parents or adult children

Rising health care costs

Affording the lifestyle I want in retirement

Impact of economy to meet financial goals

Nov. 11 Apr. 12

Source: April 2012 Merrill Edge Report

These exhibits indicate that saving for retirement has become more important that it was even just six

months ago and that the younger generation is even more concerned about retirement and more focused on

achieving financial stability than previous generations.

An article published by Bloomberg Businessweek titled “Young Consumers Pinch Their Pennies” (March

22, 2012) shows that in 2009, households led by someone below 35 had 68% less inflation-adjusted wealth

than households led by those younger than 35 in 1984. Consequently, we believe there is a new frugality

and value consciousness. Consider this: The same article says that 45% of generation Y-ers have reduced

their driving versus 24% of those 55 years and older. Having lived through a severe economic recession,

their behavior is different from that of generation X (35 to 50 years of age) and the baby boomers (51 years

of age and above).

We believe that paying off debt has become more important to Generation Y than buying a new car or a

second home. According to Richard Mason, president of corporate markets for ING US Retirement, ING’s

research shows that generation Y has entered the work force with more college debt than its parents. We

believe that a forced frugality combined with an increase in tech savvy could change the way investment

decisions are made. Traditional investors, especially in the middle income class, typically preferred to deal

with their financial advisor when making financial planning or investment decisions. Generation Y, which

we believe to be financially smart, having lived through the crisis and expecting more given their limited

resources, could be inclined to cut the middle man. We believe this generation could be selective when

allocating assets and that asset managers who do not deliver strong results might simply not appeal to them.

It appears to us that Generation Y does not often trust the market and frequently questions the status quo,

which is why it is sometimes called Generation “Why”. We think this too should not come as a surprise.

The following exhibit shows that active management has not been an effective way to protect assets from

the financial crisis:


15

Exhibit 19: Years Majority of Actively Managed Funds Beat Benchmarks

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Number of funds with positive excess returns 1,559 1,653 1,517 1,687 2,196 1,481 2,232 1,995 3,169 2,491 1,742

Number of funds with data 3,153 3,333 3,503 3,700 3,921 4,232 4,600 4,946 5,275 5,513 5,748

% of funds beating benchmark 49.4% 49.6% 43.3% 45.6% 56.0% 35.0% 48.5% 40.3% 60.1% 45.2% 30.3%

Note: Excess returns are calculated as fund return in excess of the benchmark return. Benchmark used is the primary prospectus benchmark for each fund. Actively managed US mutual funds, excluding index funds. Fund returns exclude sales charges, but include management, administrative, and 12b-1 fees.


We used Morningstar data to determine if actively managed funds add value. Our finding is that only in

2005 and 2009 did a majority of actively managed funds beat their benchmark over the past 10 years. This

is not encouraging given that clients are paying fees for the professional management of funds. We think

that the table above explains the increasing popularity of exchange-traded funds – why pay more, if you

can’t beat the market?

Exhibit 20: Passively Managed Funds have been Gaining Market Share

12% 13% 15% 15% 17% 18% 19% 21% 24% 24% 26% 27%

88% 87% 85% 85% 83% 82% 81% 79% 76% 76% 74% 73%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Passively Managed Actively Managed

Note: Percent of net assets of equity open-end mutual funds and ETFs. Funds as categorized by Morningstar.


This brings us back to the discussion of performance. Actively managed funds need to perform well to

attract assets. The pressure to do so could likely increase as investors evaluate the cost of paying high

active management fees versus the benefits of professional management. We believe Waddell & Reed

needs to improve performance to grow assets. It is known for being an active manager and we think the

new generation of investors could be even more demanding and financially savvy than the previous ones.

Younger generations are expected to rely less on advisors, which should make the assets less “sticky” and

could increase redemption rates if performance cannot justify the additional costs.


16

Significant Exposure to Equity Markets could Lead to Slow AUM Growth

With over 80% of assets in equity funds, Waddell & Reed has a significant exposure to the equity market. Given the uncertainty about an economic recovery, we believe that Waddell & Reed would not reap the benefit of a market rally in the near term.

While margins could expand at Waddell & Reed if equity markets rally, driving assets under management

higher, we assign a low probability to this scenario. With uncertainty about Europe, a decelerating of

growth in emerging markets, a lack of consumer confidence and the US recovery not gaining traction,

being heavily exposed to equity markets could cause some headwinds. We would expect further

redemptions in equities and inflows into fixed income funds, if conditions do not improve.

RBC’s Chief Investment Strategist Myles Zyblock (RBC Dominion Securities Inc.) recommends that

investors remain underweight equities. Dawn Desjardins, Assistant Chief Economist for Royal Bank of

Canada, has said that world growth is expected to fall short of the long-term trend rate by about one-quarter

of a percentage point in 2012.

The near-term outlook for Europe remains grim. And while Greece seems to be willing to remain in the

Eurozone, it is likely that austerity measures demanded by the troika could be watered down. There could

be the risk of falling into a deeper recession again, unless the economy starts gaining steam in Europe.

This would impact not only Europe, but the world economy. According to Tom Porcelli, RBC’s Chief US

Economist, GDP growth in the US was driven by exports, which accounted for 45% of the GDP growth.

The majority of US exports go into countries such as Brazil, Mexico and China. These countries, in turn,

finance their acquisitions by borrowing from European banks. A tightening of lending standards could slow

down growth globally. The consequence would be a deceleration in the rate of expansion in emerging

market economies and potentially a decline in exports for the US.

Another point of contagion is the exposure the US financial system has to Europe. According to the Bank

of International Settlement (BIS), US banks held $656 billion of euro-area debt in the fourth quarter of

2011. The BIS is also worried that central bank money printing and support for the financial sector is

reaching its limits. At the end of 2011, the world’s central bank balance sheets stood at $18 trillion, double

the pre-crisis level and about 30% of global GDP.

The BIS wrote in its annual report published in June 2012, that the persistence of loose monetary policy is

largely the result of insufficient action by governments in addressing structural problems. According to the

BIS, the positive effect and impact of central bank intervention is shrinking while the negative side effects

of loose monetary policy are growing. Put differently, low interest rates and almost unconditional liquidity

provided by central banks de-incentivize the private sector to de-lever and repair its balance sheet.

We believe that investors should not own Waddell & Reed in hopes of a fast recovery in equity markets, as

we don’t believe that structural deficiencies in the economy can be fixed quickly. While being levered to

equity markets can be beneficial in a recovery, the opposite could also be true for a further deterioration in

the economy.

Sure, the company is a conundrum in that it defies some of our conventional beliefs. For instance, it has

above industry average growth rates despite its below-peer performance in equities. The below chart

demonstrates this.


17

Exhibit 21: Equity Funds’ Organic Growth – Waddell & Reed versus Industry (US-domiciled Funds)

1.7%

1.2%

0.6%

(0.5%)

(1.2%)

(0.5%)

2.2%

(0.1%)

(1.6%)(1.5%)(2.0%)

(1.5%)

(1.0%)

(0.5%)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

1Q11 2Q11 3Q11 4Q11 1Q12

WDR Industry


Waddell & Reed was also able to achieve above industry-average organic growth rates in its fixed income

funds in recent quarters, despite being known as an “equities shop” focused on active management.

Exhibit 22: Fixed Income Funds’ Organic Growth – Waddell & Reed versus Industry (US-domiciled Funds)

3.0%

1.8%2.2%

6.9%

9.0%

3.6%

1.0%

2.0%

0.0%

2.1%

3.9%

1.8%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12E

WDR Industry


Conventional wisdom would suggest that equity outflows should have been larger than for the industry

based on weak fund performance over the past few years. This would be based on one-year and three-year

measurement periods. Likewise, one could have expected that organic growth in its fixed income funds

would have been low based on the fact that the company’s expertise is in actively managed equity funds.


18

However, Waddell & Reed seems to defy conventional wisdom in that it generates relatively strong flows

despite weak equity fund performance and has strong flows into fixed income funds despite being known

as a provider of equity funds. One explanation could be that the Waddell & Reed has a very loyal customer

base and is less likely to suffer outflows to the same degree as its competitors. This is supported by

management’s assertion that it has one of the best retention rates on assets sold through its captive sales

force.

We are impressed by this, as well. Nonetheless, despite all these desirable qualities, we are not certain how

sustainable they are. Eventually, even the most loyal customers could reach the pain point and start

withdrawing cash unless performance improves from here on. Until then, we would recommend investors

remain on the sidelines.


19

Financial Analysis

Recent Results

Waddell & Reed had a strong March quarter, with earnings of $0.55 per share exceeding consensus

estimates of $0.46. While the company’s heavy exposure to equities had been creating headwinds for some

time, it seems to have reaped the benefits of its equity bias in the current quarter as assets under

management grew 13% sequentially to $94 billion.

Market performance was not the only factor leading to sequential growth of 5.4% in revenues. Waddell &

Reed’s strategy to diversify sales and to offer new products seems to be paying off. The company generated

6.3% organic growth in AUM, reporting net flows of $1.3 billion in the quarter.

In comparison, based on ICI data, organic growth for the industry was close to zero for the same time

period. If one were to exclude money market funds, which had outflows of about $109 billion in the

quarter, organic growth for the industry would have been still lower at 3.8%.

Organic growth for the company in the March quarter was the lowest in recent history. However, we

believe that the decision to diversify the product mix, reducing exposure to equities and moving into fixed

income offerings should pay off. Net inflows of $1.5 billion into fixed income funds were the strongest

additions into this asset class – ever.

There were other encouraging signs in the quarter. While still in outflow mode, redemptions have been

declining in the company’s flagship Ivy Asset Strategy fund. With a heavy equities exposure of 80%, this

fund has been experiencing outflows for some time now. Having a large cap growth strategy, the fund has

fallen out of favor with investors in the current market environment. However, should the move towards

increasing risk exposure persist, we could see the funds flow number turning positive. This is important

given the size of the fund, which represents about 28% of total assets under management as of the end of

2011.

Nonetheless, equities as an asset class continued to suffer from outflows for a second consecutive quarter –

albeit at a lower rate. The company reported redemptions of $156 million versus inflows of $1.6 billion a

year earlier. The redemption rate continues to be above industry average for the Wholesale channel. In the

current quarter, the company reported a redemptions rate of 30.7%, down from 35.7% in the previous

quarter.

As a comparison, average redemption rates in the Wholesale channel for the industry were 27.0% for 2011

and 26.3% in 2010. Waddell & Reed had 29.5% and 29.3% for the years ended December 31, 2011 and

2010, respectively. The current quarter’s redemption rate is still a concern despite the sequential decline in

this ratio. Assets overall are less sticky compared to other distribution channels, especially the advisory

channel, which had redemption rates of about 10% over the past few quarters. Thus, performance becomes

an even more important part of the Waddell & Reed story as third-party distribution is by now the biggest

contributor of organic growth.

The most recent performance data show that while performance has been good over five years and has been

improving more recently, the three-year performance has been subpar.

This is true for equity assets as well as for fixed income assets.


20

Exhibit 23: Rating by Number of Funds as of 1Q12

Fund Rating By Rank 1 Year 3 Years 5 Years

Lipper

Equity Funds Top Quartile 24% 29% 52%

Top Half 43% 39% 79%

Fixed Income Funds Top Quartile 47% 19% 53%

Top Half 58% 44% 73%

All Funds Top Quartile 30% 26% 52%

Top Half 47% 40% 78%

Morningstar

Equity Funds 4 & 5 Star 47% 12% 57%

All Funds 4 & 5 Star 42% 9% 53%

Source: Company reports; Lipper; Morningstar

Looking at ratings weighted by assets leads to the same conclusion. The three-year performance could be

an issue in the future as performance is rolled forward.

Exhibit 24: Rating by Assets as of 1Q12

Fund Rating By Rank 1 Year 3 Years 5 Years

Lipper

Equity Funds Top Quartile 11% 18% 77%

Top Half 67% 21% 88%

Fixed Income Funds Top Quartile 62% 10% 62%

Top Half 68% 46% 79%

All Funds Top Quartile 21% 16% 74%

Top Half 67% 26% 86%

Morningstar

Equity Funds 4 & 5 Star 29% 8% 72%

All Funds 4 & 5 Star 31% 6% 70%


While we are impressed with the flows in the current quarter, we are not convinced yet that fundamentals

could improve. The reason for our scepticism is the trend in the one-year performance. We have created

exhibits which show the volatility in the one-year performance from one quarter to the next. Our verdict:

performance has been anything but steady. If fund performance does not improve, we believe the one-year

performance could turn into a three-year performance and the three-year performance could blend with the

five-year performance. This could lead to outflows in the future unless company-wide performance starts

improving.


21

Exhibit 25: One-year Performance by Number of Funds (Equally Weighted)

1 Year Performance - Number of Funds

0%

10%

20%

30%

40%

50%

60%

70%

80%

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12

Equity Funds - Lipper Top Quartile Equity Funds - Lipper Top Half Morningstar 4 & 5 Star Ratings


Exhibit 26: One-year Performance Weighted by Assets

1 Year Performance - Weighted by Assets

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12

Equity Funds - Lipper Top Quartile Equity Funds - Lipper Top Half Morningstar 4 & 5 Star Ratings


It seems that Waddell & Reed’s funds were actually starting to perform well in late 2010 and early 2011,

but the trend reversed as the year progressed. Specifically, we saw a decline in the Lipper rankings from the

top quartile to the top half, which should make it more difficult for the company to differentiate itself from

other fund providers.

Performance was probably one of the reasons why another flagship Waddell & Reed fund, Global Natural

Resources, was removed from a model portfolio, which resulted in outflows in the March quarter. This

fund is the company’s second-largest fund, with over $4.4 billion in assets under management. The fund,

which is subadvised by Mackenzie Financial, had a very difficult year in 2008, losing 61.4% due to its

significant exposure to emerging markets. On a cumulative basis, the fund has been underperforming its

category average by 12.6%, meaning that it has underperformed its investment peer group over the past

three years. While outflows out of funds sub-advised by other managers is not as big an issue as outflows

of funds managed directly by the company (as there should be some offset on the expense side to the lost

revenue), we would still prefer inflows as the asset management business is a scale business.

Good

Bad

Good

Bad


22

We believe performance has to improve at Waddell & Reed to attract more assets. In the meantime, the

company has new initiatives to increase organic growth. It is planning to deepen relationships with some of

the largest distributors which, according to management, are in a nascent stage. It is developing two new

products, the Ivy International Balanced Fund and the Ivy Global Income Allocation Fund, to gather assets.

However, we believe that sales should follow performance and as such, asset growth could be somewhat

slower than for its peers.

Exhibit 27: Recent Net Flows have been Soft in Equities ($ in Billion)

$1.56

$1.18

$0.46

($0.16)

$0.55 $0.53$0.70

$1.32

$1.54

($1.26)

($1.500)

($1.000)

($0.500)

$0.000

$0.500

$1.000

$1.500

$2.000

1Q11 2Q11 3Q11 4Q11 1Q12

Equity Funds Fixed Income Funds


Financial Projections

We expect Waddell & Reed to grow its total AUM at year-end from $83.2 billion in 2011 to $97.6 billion

in 2012 and $109.6 billion in 2013, mainly driven by growth in the equity asset class.

Exhibit 28: AUM Roll Forward

Assets under management

($ in billion) 2009A 2010A 2011A 2012E 2013E

Consolidated Total AuM

Beginning assets $47.0 $69.8 $83.7 $83.2 $97.6

Sales (net of commissions) 19.7 21.7 23.8 25.6 29.1

Redemptions (10.9) (17.0) (19.5) (22.2) (24.0)

Net sales $8.7 $4.7 $4.3 $3.3 $5.2

Net exchanges (0.0) 0.0 (0.0) (0.0) -

Reinvested dividends & capital gains 0.6 0.7 0.7 0.2 -

Market action 13.5 8.5 (5.5) 10.9 6.8

Ending assets $69.8 $83.7 $83.2 $97.6 $109.6- - - - -

Net flows $9.3 $5.4 $5.0 $3.5 $5.2

Source: RBC Capital Markets Estimate

We expect equity funds AUM to increase from $67.6 billion in 2011 to $78.2 billion in 2012 and $88.0

billion in 2013. Our projections incorporate net flows of $273 million in 2012 and $3.3 billion in 2013. The

increase in flows in 2013 is a result of a shift in customer demand towards equity funds.


23

We expect client interest in the fixed income asset class to continue, with fixed income funds’ AUM

increasing from $14.0 billion in 2011 to $18.1 billion in 2012 and $20.3 billion in 2013. We are projecting

net flows of $3.3 billion in 2012 and $2.0 billion in 2013. Our expectation is that investors could move

from fixed income funds to equity funds in 2013, resulting in lower net additions than in 2012.

Given our expectations for increasing AUM in the next few years, we are forecasting net revenues to

increase, going from $929.5 million in 2011 to $1.0 billion in 2012 and $1.1 billion in 2013, mainly due to

increasing investment management fees revenues. However, we believe net operating margins could

decline from the 31.4% seen in 2011 to 29.8% in 2012 and expand to 31.2% in 2013, as equity funds are

projected to receive inflows. We expect Waddell & Reed to generate $298.1 million in operating income in

2012 and $344.0 million in 2013, compared to operating income of $292.0 million in 2011.

Our diluted EPS estimates for 2012 and 2013 are $2.24 per share and $2.59 per share, respectively. This

compares to diluted EPS of $2.05 in 2011.


24

Valuation

Each of the three exhibits below show how Waddell & Reed has traded: On an absolute P/E basis, on a

basis of Waddell & Reed’s P/E relative to that of the S&P 500, and on a basis which looks at Waddell &

Reed’s P/E relative to that of a broad valuation index we’ve constructed for asset managers in general.

On an absolute P/E basis, Waddell & Reed’s shares have traded at a discount to historical levels over the

past five and a half years.

Exhibit 29: WDR’s Forward Looking P/E Multiples

0x

5x

10x

15x

20x

25x

30x

Jan-0

7

Jul-

07

Jan-0

8

Jul-

08

Jan-0

9

Jul-

09

Jan-1

0

Jul-

10

Jan-1

1

Jul-

11

Jan-1

2

Jul-

12


On a relative basis, Waddell & Reed has been trading at a premium to the S&P 500. However, the shares

have recently started to trade in line with the S&P

Exhibit 30: WDR’s Forward Looking P/E Relative to S&P 500 Index

0.4x

0.6x

0.8x

1.0x

1.2x

1.4x

1.6x

1.8x

Jan-0

7

Jul-

07

Jan-0

8

Jul-

08

Jan-0

9

Jul-

09

Jan-1

0

Jul-

10

Jan-1

1

Jul-

11

Jan-1

2

Jul-

12


Waddell & Reed has been trading at a discount to peers on average over the past five and half years.


25

Exhibit 31: WDR’s Forward Looking P/E Relative to RBC Asset Managers Index

0.3x

0.4x

0.5x

0.6x

0.7x

0.8x

0.9x

1.0x

1.1x

1.2x

1.3x

Jan-0

7

Jul-

07

Jan-0

8

Jul-

08

Jan-0

9

Jul-

09

Jan-1

0

Jul-

10

Jan-1

1

Jul-

11

Jan-1

2

Jul-

12

Note: RBC Asset Managers Index includes BLK, EV, IVZ, LM, TROW, WDR, BEN, JNS, AB, ART, AMG, CNS, CLMS, GBL, PZN


The asset managers are currently trading at 12.3x calendar year 2013 estimated earnings. Over the past 10

years Waddell & Reed has been trading at a 7% discount to peers. We believe that the discount is still

justified given the company’s significant exposure to equity funds and the weak performance of its two

largest funds. We arrive at our price target using a price-to-earnings multiple of 11.4x, which represents a

7% discount to the company’s peers, and our 2013 calendar year earnings estimate of $2.59 per share. Our

price target is $30.

Market Sensitivity Analysis

Our EPS sensitivity analysis to equity market movements starts with our published estimates as the base

case. Our base case assumes uniform market appreciation, with equity markets appreciating 2%

sequentially and fixed income markets appreciating 1% sequentially, starting in calendar fourth quarter of

2012. For simplification, we assume the alternative asset classes appreciate at the same rate as the equity

markets and thus assign an appreciation rate of 2% sequentially. We believe these assumptions are in line

with long-term historical average returns. For the bull case scenario, we assume equity markets and

alternative asset classes appreciate 4% sequentially, with fixed income appreciation unchanged from the

base case scenario. For the bear case, we assume zero appreciation within the equity markets and

alternative asset classes. We apply these assumed appreciation rates uniformly starting in the calendar

December quarter (4Q12) and throughout calendar 2013.

Exhibit 32: EPS Sensitivity to Equity Market Movements

Scenario 2013 P/E

2013

Peer P/E

(Discount)/

Premium 2013 EPS PT

Base Case 11.4x 12.3x -7% $2.59 $30

Bear Case 11.4x 12.3x -7% $2.36 $27

Bull Case 11.4x 12.3x -7% $2.83 $32

Source: RBC Capital Markets estimate


26

Exhibit 33: Valuation Matrix

Market Current 52-week Div. Enterprise YTD YTD

Company Ticker Cap ($m) Price High Low Yield Value ($m) 2012E 2013E 2012E 2013E 2011A 2012E 2013E EV/AuM P/AuM Price Perf. Total Return

Traditional Asset Managers

BlackRock BLK $24,213 $173.31 $209.37 $137.00 3.46% $33,397.86 $13.08 $14.59 13.2x 11.9x 9.2x 9.1x 8.2x 0.009x 0.007x (2.8%) (1.1%)

T.Rowe Price TROW 15,681 61.47 $66.00 $44.68 2.21% $15,111.57 3.27 3.76 18.8x 16.3x 11.6x 10.4x 9.2x 0.027x 0.028x 7.9% 9.1%

INVESCO IVZ 9,655 21.54 $26.94 $14.52 3.20% $10,680.89 1.82 2.10 11.9x 10.2x 9.2x 9.0x 8.0x 0.016x 0.014x 7.2% 8.6%

Legg Mason LM 3,616 25.61 $32.58 $22.36 1.72% $3,499.53 1.67 2.27 15.4x 11.3x 7.3x 6.7x 6.1x 0.005x 0.006x 6.5% 7.2%

Franklin Resources BEN 23,746 110.35 $135.21 $87.71 0.98% $19,075.69 8.92 9.74 12.4x 11.3x 6.7x 6.7x 6.2x 0.026x 0.033x 14.9% 15.4%

Waddell & Reed WDR 2,457 28.46 $38.73 $22.85 3.51% $2,023.61 2.21 2.44 12.9x 11.6x 6.5x 6.2x 5.6x 0.022x 0.026x 14.9% 16.8%

Janus Capital Group Inc. JNS 1,361 7.22 $9.70 $5.36 3.32% $1,401.99 0.57 0.68 12.7x 10.6x 4.0x 5.0x 4.6x 0.009x 0.008x 14.4% 16.1%

Eaton Vance Corp. EV 3,054 26.43 $29.64 $20.07 2.88% $3,642.09 1.83 2.04 14.4x 13.0x 8.0x 8.7x 8.3x 0.018x 0.015x 11.8% 13.4%

Federated Investors, Inc. FII 2,158 20.71 $23.89 $14.36 4.64% $2,115.35 1.64 1.76 12.6x 11.8x 7.7x 7.1x 6.7x 0.006x 0.006x 36.7% 40.0%

AllianceBernstein AB 1,260 11.98 $18.76 $11.55 8.68% $1,220.60 1.04 1.17 11.5x 10.3x 2.5x 2.6x 2.5x 0.003x 0.003x (8.4%) (5.9%)

Artio Global Investors ART 187 3.14 $11.22 $2.83 2.55% $164.13 0.16 0.04 19.8x n/m 1.2x 10.0x n/m 0.006x 0.007x (35.7%) (34.4%)

Affiliated Manager Group AMG 5,528 107.63 $115.66 $70.27 0.00% $7,276.03 7.28 8.58 14.8x 12.5x 14.9x 13.3x 11.3x 0.020x 0.015x 12.2% 12.2%

Cohen & Steers CNS 1,377 31.91 $40.93 $23.79 2.26% $1,242.58 1.63 1.93 19.5x 16.5x 15.3x 10.9x 9.5x 0.028x 0.031x 10.4% 11.7%

Calamos CLMS 221 10.85 $14.66 $9.40 3.50% $113.22 0.92 0.89 11.9x 12.3x 0.7x 0.9x 0.8x 0.003x 0.006x (13.3%) (11.9%)

GAMCO GBL 1,214 45.57 $52.98 $35.81 0.35% $1,169.06 3.13 3.30 14.6x 13.8x 9.2x 8.4x 7.8x 0.032x 0.033x 4.8% 5.6%

Pzena Investment Mgmt PZN 266 4.11 $7.39 $3.18 2.92% $268.93 0.33 0.39 12.3x 10.5x 6.2x 6.8x 6.5x 0.018x 0.018x (5.1%) (1.3%)

Mean 2.89% 14.3x 12.3x 7.5x 7.6x 6.7x 0.016x 0.016x 4.8% 6.3%

Median 2.90% 13.1x 11.8x 7.5x 7.8x 6.7x 0.017x 0.015x 7.6% 8.9%

Min 0.00% 11.5x 10.2x 0.7x 0.9x 0.8x 0.003x 0.003x (35.7%) (34.4%)

Max 8.68% 19.8x 16.5x 15.3x 13.3x 11.3x 0.032x 0.033x 36.7% 40.0%

Alternative Asset Managers

Och-Ziff OZM $2,920 $7.05 $13.23 $6.56 5.67% $2,493.47 $0.48 $1.15 6.2x 5.4x 8.9x 3.6x 3.3x 0.083x 0.097x (16.2%) (14.8%)

Apollo Global Manager APO 1,696 13.41 $17.94 $8.85 7.46% $7,415.10 (0.86) 2.22 6.0x 4.6x -24.3x 7.8x 6.1x 0.086x 0.020x 8.1% 14.9%

Blackstone BX 6,727 13.15 $17.78 $10.51 3.04% $23,469.76 (0.57) 1.47 9.0x 6.4x 46.7x 38.3x 28.3x 0.123x 0.035x (6.1%) (4.0%)

KKR KKR 3,253 14.00 $16.10 $8.95 4.29% $43,312.58 0.73 2.06 6.8x 6.4x 73.7x 156.8x 102.3x 0.695x 0.052x 9.1% 12.7%

Fortress Investment Group FIG 1,950 3.79 $4.79 $2.67 5.28% $2,518.22 0.46 0.41 9.2x 6.9x 11.0x 10.4x 7.6x 0.054x 0.042x 12.1% 15.3%

Mean 5.15% 7.4x 5.9x 23.2x 43.4x 29.5x 0.208x 0.049x 1.4% 4.8%

Median 5.28% 6.8x 6.4x 11.0x 10.4x 7.6x 0.086x 0.042x 8.1% 12.7%

Min 3.04% 6.0x 4.6x -24.3x 3.6x 3.3x 0.054x 0.020x (16.2%) (14.8%)

Max 7.46% 9.2x 6.9x 73.7x 156.8x 102.3x 0.695x 0.097x 12.1% 15.3%

S&P 500 SP50 $12,316,922 $1,362.66 $1,422.38 $1,074.77 2.21% $96.42 $104.26 14.1x 13.1x 8.4% 8.4%

S&P 500 / Asset Mgmt & Custody Banks SPT30 134,632 120 138.27 94.63 2.53% 9.84 10.32 12.7x 12.1x 5.3% 5.3%

S&P Comp. 1500 / Asset Mgmt & Custody Banks SPT29 154,759 131 149.00 102.23 2.59% 10.56 11.04 12.8x 12.3x 6.3% 6.3%

S&P Mid Cap 400 / Asset Mgmt & Custody Banks SPT31 16,977 225 245.14 168.41 2.50% 16.40 16.85 14.0x 13.6x 14.7% 14.7%

S&P 500 / Financials SP621 1,737,330 $193.42 215.37 151.85 2.07% 14.57 17.63 13.5x 11.2x 10.4% 10.4%

Current P/EConsensus CY EPS EV/EBITDA Consensus

Asset Management Research

Source: FactSet (Priced as of market close July 20, 2012 ET); RBC Capital Markets


27

Company Description

Founded in 1937, Waddell & Reed, Inc. (NYSE:WDR) is one of the oldest mutual fund companies in the

United States. The company provides investment management, investment product underwriting and

distribution, and shareholder services administration to mutual funds and institutional and separately

managed accounts. It offers four different fund families – Waddell & Reed Advisory Funds (mutual funds),

Ivy Funds (mutual funds), Ivy Funds Variable Insurance Portfolios (variable annuities) and InvestEd

Portfolios (529 college savings plans).

The company operates through three distinct distribution channels:

Through the Advisory channel, Waddell & Reed serves primarily the middle class, the mass affluent

market, families and businesses. It uses its own network of financial advisors to provide personal

financial planning services in the United States. The advisors provide personal financial plans and

investment strategies for retirement, education, insurance and estate planning needs. The Waddell &

Reed Advisors funds are offered through Waddell & Reed advisors, the company’s network of personal

financial planners.

Through the Wholesale channel, the company distributes its retail funds (the Ivy Funds, Ivy Fund

Variable Insurance Portfolios and InvestEd Portfolios) through broker/dealers, independent registered

investment advisors, and retirement and insurance platforms. Ivy Funds are offered through the

company’s Wholesale channel.

Through the Institutional channel, the company manages assets for institutional clients. Waddell &

Reed’s largest client base is funds which utilize it as sub-advisors. These clients either lack the scale

and/or track record to manage funds internally or choose to market multi-manager styles. It offers its

investment strategies to defined benefit plans, pension plans (defined benefit and defined contribution)

and endowments.

As of December 2011, the company had $83.2 billion in assets under management. While it offers a broad

range of products, it is still focused mostly on domestic equities. The majority of its assets, more than 80%,

are invested in equities, of which 73% were domestic and 27% were international equities.

Waddell & Reed employed a total of 1,616 individuals full-time at the end of 2011, of which 1,235 were

home office and Legend employees, and the remaining 381 employees were in charge of administration

and field supervision. Legend is Waddell & Reed’s mutual fund distribution and retirement planning

subsidiary which serves employees of school districts and other not-for-profit organizations. The

company’s sales force, totaling 1,816 financial advisors, operated out of 163 offices across the United

States, and 256 individual advisor offices. The company claims to have one of the largest sales forces in the

United States selling primarily mutual funds, serving more than 502,000 mutual fund customers in the

advisors channel.


28

Milestones:

1937 Waddell & Reed was founded by Chauncey Waddell and Cameron Reed, two World War I

pilots

1940 Waddell & Reed introduced one of the first mutual funds in the United States to be

registered under the Investment Company Act of 1940

1950 Waddell & Reed became a top five mutual fund sales organization in the United States

1958

Waddell & Reed became the first company to open a mutual fund sales outlet in a

department store – in Buffalo, New York. The company was also the first one to hire part-

time agents

1963 Dudley F. Cates resigned as president and was succeeded by Cameron Reed, the founder

and former president.

1965 Cameron Reed resigned and sold his stockholdings to the du Pont group, giving it 24% of

the voting stock

1969 Continental Investment Corporation of Boston bought Waddell & Reed after the company’s

performance in its funds deteriorated around the bear market in 1966

1981 Liberty National Insurance Holding Company, the predecessor of Torchmark Corporation,

acquired Waddell & Reed

1998 Torchmark Corporation spun off Waddell & Reed in an initial public offering and

distributed WDR common shares to Torchmark shareholders

2000 The United Group of Mutual Funds was renamed Waddell & Reed Advisors Funds, Inc.

2003 Waddell & Reed launched the new Ivy Funds and officially entered wholesale distribution

2007 Waddell & Reed reached $50 billion in assets under management on its 70th

anniversary

Source: Company Web site; RBC Capital Markets


29

Organizational Structure

Waddell & Reed operates through its various subsidiary companies:

Its investment advisory business operates primarily through Waddell & Reed Investment Management

Company (WRIMCO), a registered investment advisor; Ivy Investment Management Company (IICO), the

registered investment advisor for Ivy Funds; and Legend Advisory Corporation, the registered investment

advisor to Legend. The investment advisory business generated about 44% of total revenues in 2011.

The underwriting and distribution business operates through three broker/dealers: Waddell & Reed, Inc.

(W&R), national distributor and underwriter of shares of the Advisors Funds, other mutual funds and of

insurance products; Ivy Funds Distributor, Inc. (IFDI), distributor and underwriter for the Ivy Funds); and

Legend Equities Corporation (LEC), a mutual fund distributor and retirement planning subsidiary serving

not-for profit organizations. The underwriting and distribution business generated about 45% of total

revenues in 2011.

Waddell & Reed Services Company (WRSCO) provides accounting and transfer-agency services to the

Advisory Funds, Ivy Funds, Ivy Funds VIP and InvestEd. Shareholder services generated about 11% of

total revenues in 2011.

Exhibit 34: Organization Structure

Source: Company reports

Products & Services

Investment management products

The company offers mutual fund products in various investment styles and options. As of December 31,

2011, WDR offered 80 registered open-ended mutual fund options. The main funds offered by the company

are:

Advisor Funds: Variable products (variable annuity funds) offered through multiple channels.

Ivy Funds: Offered through both the Advisors channel and Wholesale channel. These mutual funds offer

exposure to a range of asset classes, investment styles and sectors.

Ivy Funds VIP (Variable Insurance Portfolios): Offered through the company’s financial advisors and

Legend advisors and occasionally through the Wholesale channel. Ivy Funds VIP serves as the underlying

investment for a number of insurance products, including variable annuities and variable life insurance

policies.


30

InvestEd: Similar to Ivy Funds VIP, the product is offered through Waddell & Reed’s financial advisors

and Legend advisors and sometimes through the Wholesale channel. The Ivy Fund InvestEd 529 plan

offers various options to save for college.

Other Products

Waddell & Reed offers other products in addition to the mutual fund products mentioned above.

Annuity: The company distributes its business partners’ annuity products through its Advisor channel. The

annuity products offer Ivy Funds VIP as the investment vehicle.

Retirement and Life Insurance: Waddell & Reed offers retirement and life insurance products to its

customers through the Advisor channel. The products are underwritten by the company’s business partners.

The company also offers life insurance and disability products underwritten by multiple carriers through its

insurance agency subsidiary, Waddell & Reed financial advisors.

Asset allocation and investment advisory: Waddell & Reed offers fee-based asset allocation and

investment advisory products to its Advisor channel’s customers under the following brand names:

Managed Allocation Portfolio (MAP)

MaPPlus

Strategic Portfolio Allocation (SPA)

Together, MAP, MaPPlus and SPA products had US$6.0 billion in assets under management as of

December 31, 2011.

Distribution Channels

The company operates its business through three different distribution channels:

Exhibit 35: AUM by Channel (December 31, 2011)

Advisors

channel

38%

Wholesale

channel

49%Institutional

channel

13%



31

Exhibit 36: AUM Breakdown by Investor Type (December 31, 2011)

Institutional

12%

Retail / HNW

88%


Advisor Channel

This channel comprises independent financial advisors responsible for the sale of the company’s retail

products. The advisors’ target groups are middle class and mass affluent clients, and businesses. The

typical financial planning products sold in this channel are retirement planning, estate planning, education

funding, and other products designed to address various financial needs of clients. As of December 31,

2011, the total assets under management in this channel were $31.7 billion. The company prides itself on

having one of the lowest redemption rates in the industry for this channel. The number of financial advisors

associated with the company has been declining over the years due to the company’s push to improve

productivity. Gross revenue per advisor was $156,000 for FY2011 compared to $119,000 for the year

ended December 31, 2010. The company is trying to recruit experienced advisors to further improve

productivity. As of year-end 2011, the sales force headcount stood at 1,816 financial advisors serving

502,000 mutual fund customers.

Wholesale Channel

Retail mutual funds are distributed through broker/dealers, registered investment advisors, including

Legend Group of subsidiaries (Legend), and many retirement platforms utilizing a team of internal/external

and hybrid wholesalers. Hybrid wholesaling is a new approach to selling that relies on technology

(electronic marketing and communication via email / telephone) and face-to-face meetings in order to cover

large territories.

The primary focus is to distribute Ivy Funds through the Wholesale channel. The company restructured its

wholesaler territories in 2010 into smaller territories to build relationships with additional distribution

partners in these territories. As such, Waddell & Reed has been building its wholesaler force which stood at

51 wholesalers at year-end 2011. As of December 31, 2011, this channel had total AUM of $41.0 billion,

and it is also the company’s fastest growing channel, with annual sales growth rate of 36% since 2007. The

channel growth has been fuelled by good performance of the Ivy Funds family. The Ivy Asset Strategy

fund is the best-selling fund and comprised 47% of total sales through this channel. Based on management,

the company is encouraging wholesalers to sell other WDR funds in order to reduce concentration risk as

the Asset Ivy Strategy fund comprises over 30% of total assets under management companywide.

Institutional Channel

The company manages various investment styles for institutional clients. The largest client type served

through this channel is funds which hire Waddell & Reed to act as a sub-advisor for their branded funds.

The funds either lack the scale or track record to compete or use Waddell & Reed as part of their multi-

manager strategy. Other clients include corporations, foundations, endowments, Taft-Hartley plans and

public plans such as defined benefit and defined contribution plans. At the end of FY2011, the total AUM

for this channel was $10.5 billion, of which 60% was attributable to sub-advisory relationships.


32

AUM by Client and Asset Class

WDR had AUM of US$83.2 billion at the end of 2011. The company’s assets under management are

invested in equity, fixed income and money market instruments, with the majority of these assets being

allocated to equities.

Exhibit 37: AUM by Asset Class (December 31, 2011)

Cash

2%

Equities

84%

Fixed Income

14%

Note: Cash includes money market funds. Source: Company reports, RBC Capital Markets

The Ivy Asset Strategy fund and Ivy Global Natural Resources fund comprised a third of total assets under

management as of December 31, 2011. The company is trying to address this concentration risk by

changing its compensation structure to entice wholesalers to sell more of its other products. Waddell &

Reed’s top five mutual funds make up about 43% of total assets under management.

Exhibit 38: Five Largest Mutual Funds by AUM (December 31, 2011)

Ivy High

Income

4%

Ivy Global

Natural

Resources

5%

Advisors Asset

Strategy

3%

Advisors Core

Investment

3%

Ivy Asset

Strategy

28%

Other

57%



33

Management Team

The table below summarizes the management team’s experience.

Name Title Background

Henry John

Herrmann

Chairman & Chief

Executive Officer

Mr. Herrmann has served as chairman of the board since January 2010. He was

named chief executive officer in 2005, and named president in 1998 prior to

Waddell & Reed's initial public offering. Mr. Herrmann managed the Waddell

& Reed Advisors New Concepts Fund from its inception in June 1983 to

February 1989. From 1976 to 1987, he was portfolio manager of the Waddell

& Reed Advisors Vanguard Fund. Mr. Herrmann began his career with

Waddell & Reed in 1971. Prior to joining Waddell & Reed, he was an

investment analyst specializing in high technology stocks for a major New

York City bank and two Wall Street brokerage firms.

Michael L. Avery President Mr. Avery has been president of the company since January 2010. Prior to that,

he served as chief investment officer from June 2005 to February 2011 and as

senior vice president from June 2005 until January 2010. He has had various

leadership roles at Waddell & Reed’s subsidiary companies. Mr. Avery joined

the company in June 1981 and has served as a mutual fund portfolio manager

since 1994.

Daniel Paul

Connealy

Senior VP & Chief

Financial Officer

Mr. Connealy has been senior vice president and CFO since joining the

company in June 2004. Prior to joining WDR, Mr. Connealy served as a

director of Gold Banc Corporation, Inc., a director of the Russell Investment

Company mutual funds, CFO of Stilwell Financial, Inc., and as a partner at

PricewaterhouseCoopers LLP.

Philip Sanders Senior VP & Chief

Investment Officer

Mr. Sanders serves as the CIO of Waddell & Reed Investment Management

Company and Ivy Investment Management Company. He has 22 years of

industry experience and has been with Waddell & Reed for 12 years. Previous

experience includes: portfolio manager of several Waddell & Reed Advisors

Funds and Ivy Funds and Portfolio Manager for Banc of America Capital

Management, the investment management division of Bank of America.

Michael D.

Strohm

Senior VP & Chief

Operating Officer

Mr. Strohm has been senior vice president of the company since January 1999

and chief operations officer since March 2001. In addition, he has served as

president of Waddell & Reed Services Company, a transfer agent subsidiary of

the company, since June 1999, as chief executive officer of WRI since

December 2001 and as chief operating officer since March 2005. Mr. Strohm

joined the company in June 1972.

John E. Sundeen Senior VP & Chief

Administrative

Officer

Mr. Sundeen has been senior vice president since July 1999 and chief

administrative officer – Investments since January 2006. Previously, he served

as chief financial officer from July 1999 to June 2004 and as treasurer from

July 1999 to January 2006. Mr. Sundeen joined the company in June 1983.

Source: SNL Financial; Morningstar


34

Investment Risks and Price Target Impediments

Decline in security markets could impact Waddell & Reed’s earnings.

Growth of assets under management is driven by inflows and market performance. A decline in security

markets would result in lower assets under management, potentially offsetting any new money into the

various funds. The value of investments can be driven by macro economic events over which the company

has no control. A reduction in asset levels could lead to lower earnings as management fees would be

applied to lower assets under management. Our price target would likely have to be revised downward if

AUM were to decrease

A reduction in risk appetite could lead to lower earnings

A potential adverse effect of a decline in financial markets or further deterioration of the economy could be

an increase in risk aversion. A political, economic or business crisis could lead to an increase in

redemptions and lower assets under management as investors would convert their assets into cash. We do

not model out a scenario like this as it is difficult to determine extreme events. As such, we would have to

revise our earnings forecast and reduce our price target if such an event were to occur.

Weak fund performance could lead to outflows and lower earnings

Waddell & Reed’s ability to attract assets and grow earnings is dependent on the performance it generates.

Weak performance, especially in its equity fund offerings could increase redemptions and lower inflows of

new money. This could negatively impact our revenue and earnings forecast as higher investment advisory

fees are earned with equity products. Our price target would have to be revised downward if performance

deteriorated further.

Regulatory changes could adversely impact Waddell & Reed’s business.

Changes in regulations (legal, regulatory, accounting, tax, compliance) can negatively impact operations,

revenues and earnings by increasing expenses and/or reducing investor interest in investment products. We

would have to revise our forecasts based on the regulatory changes, which could negatively impact our

price target.

Impairment of intangibles could lead to lower earnings.

Waddell & Reed has substantial intangibles. About 20% of total assets, or over $220 million consist of

goodwill and identifiable intangibles assets. Any material deviation from key assumptions about the

business and its prospect due to changes in market conditions or other external factors could lead to

impairment charges. We would likely have to lower our earnings estimate in the quarter the charges occur.

This could have a negative impact on the price target.

Competition could pressure margins

The asset management business is very competitive. There is a trend toward lower fees in some segments

of the investment management business. New rules adopted by the SEC to improve mutual fund corporate

governance could put further downward pressure on fees. Margins could decline as a result. This could

negatively impact our price target.

Likewise, Waddell & Reed competes with stock brokers, mutual funds, investment banking firms,

insurance companies, banks and other financial institutions. These competitors could have larger resources

than Waddell & Reed, broader product offering or provide services at lower rates. Consequently, the

company could lose clients to competitors. If asset under management should decline, we would have to

revise our earnings estimate and our price target.


35

Source: Company filings; RBC Capital Markets Estimate

($ in '000) 1QA 2QE 3QE 4QE 1QE 2QE 3QE 4QE 2011A 2012E 2013E

Income Model

Equity funds $115,815 $117,960 $119,535 $124,475 $125,264 $130,427 $135,794 $139,852 $467,884 $477,785 $531,338

Fixed income funds 18,981 20,134 21,661 22,635 23,480 24,433 25,435 26,202 62,291 83,411 99,550

Money market funds 105 96 97 97 116 132 132 131 423 394 511

Investment management fees $134,900 $138,191 $141,292 $147,206 $148,860 $154,993 $161,361 $166,185 $530,599 $561,589 $631,399

Advisory Channel 76,680 77,544 78,346 79,809 79,530 81,823 84,176 85,661 290,077 312,379 331,190

Wholesale Channel 60,810 64,435 65,773 68,031 71,300 74,533 77,909 80,560 242,616 259,049 304,301

Underwriting and distribution fees 137,490 141,979 144,119 147,840 150,830 156,355 162,085 166,221 532,693 571,428 635,491

Shareholder service fees 34,228 36,220 36,810 37,829 38,033 39,495 41,014 42,134 131,885 145,087 160,676

Total operating revenues $306,618 $316,390 $322,222 $332,875 $337,724 $350,844 $364,460 $374,539 $1,195,177 $1,278,104 $1,427,566

Total net revenues $240,781 $246,799 $253,161 $259,402 $260,720 $271,094 $283,435 $288,340 $929,485 $1,000,143 $1,103,588

Advisory Channel - direct expenses $53,676 $54,281 $55,626 $55,069 $55,830 $57,603 $59,765 $58,250 $204,358 $218,651 $231,448

Advisory Channel - indirect expenses 26,367 27,520 28,475 30,059 29,004 30,272 31,323 33,065 97,414 112,421 123,663

Wholesale Channel - direct expenses 65,837 69,590 69,061 73,473 77,004 79,750 81,025 86,199 265,692 277,962 323,978

Wholesale Channel - indirect expenses 13,595 13,452 13,686 15,202 14,955 14,797 15,055 16,722 48,567 55,935 61,528

Underwriting and distribution expenses $159,475 $164,842 $166,849 $173,802 $176,792 $182,422 $187,168 $194,235 $616,031 $664,968 $740,617

Compensation and related costs 45,402 44,295 43,500 47,268 45,593 47,364 49,202 53,185 $161,401 $180,465 $195,343

General and administrative 19,325 22,230 25,640 23,839 22,031 23,119 26,665 24,792 80,533 91,033 96,607

Subadvisory fees 6,271 7,620 7,761 7,997 8,767 9,122 9,492 9,772 29,885 29,649 37,153

Depreciation 3,472 3,472 3,472 3,472 3,472 3,472 3,472 3,472 15,235 13,888 13,888

Total operating expenses $233,945 $242,458 $247,222 $256,378 $256,654 $265,499 $276,000 $285,455 $903,085 $980,003 $1,083,607

Operating income $72,673 $73,931 $75,000 $76,497 $81,070 $85,345 $88,460 $89,084 $292,092 $298,102 $343,959

Investment and other income/(loss) $4,056 $4,056 $4,056 $4,056 $4,056 $4,056 $4,056 $4,056 $2,049 $16,224 $16,224

Interest expense (2,827) (2,827) (2,827) (2,827) (2,827) (2,827) (2,827) (2,827) (11,413) (11,308) (11,308)

Income before taxes $73,902 $75,160 $76,229 $77,726 $82,299 $86,574 $89,689 $90,313 $282,728 $303,018 $348,875

Provision for taxes $26,515 $28,185 $28,586 $29,147 $30,862 $32,465 $33,634 $33,867 107,269 112,433 130,828

Net income $47,387 $46,975 $47,643 $48,579 $51,437 $54,109 $56,056 $56,446 $175,459 $190,584 $218,047

Earnings per share - diluted $0.55 $0.55 $0.56 $0.57 $0.61 $0.64 $0.67 $0.67 $2.05 $2.24 $2.59

Annual growth rate 4.1% (5.0%) 20.5% 22.0% 9.8% 16.5% 19.0% 17.5% 11.6% 9.3% 15.7%

Weighted average share count - diluted 85,606 85,356 85,111 84,871 84,619 84,373 84,131 83,895 85,793 85,236 84,255

Share buybacks (shares in '000) 250 245 240 251 246 242 237 735 976

Share repurchase

Assumed share price $30.00 $30.60 $31.21 $31.84 $32.47 $33.12 $33.78 0 $30.60 $32.80

Quarterly increase in FII's share price 0% 2% 2% 2% 2% 2% 2% 0 4.0% 8.0%

Funds allocated to repurchases ($ '000) $7,500 $7,500 $7,500 $8,000 $8,000 $8,000 $8,000 $0 $22,500 $32,000

Shares repurchased in the period ( in '000) 250 245 240 251 246 242 237 - 735 976

Assets under management

($ in million) 1QA 2QE 3QE 4QE 1QE 2QE 3QE 4QE 2011A 2012E 2013E

Consolidated Total AuM

Beginning assets 83,157 93,792 91,941 95,194 97,613 100,447 103,379 106,413 83,673 83,157 97,613

Sales (net of commissions) 6,115 6,409 6,381 6,672 6,916 7,152 7,397 7,651 23,807 25,578 29,116

Redemptions (4,995) (5,787) (5,619) (5,836) (5,702) (5,888) (6,080) (6,280) (19,520) (22,237) (23,950)

Net sales $1,120 $622 $762 $836 $1,214 $1,264 $1,316 $1,371 $4,287 $3,341 $5,166

Net exchanges (1) - - - - - - - (2) (1) -

Reinvested dividends & capital gains 184 - - - - - - - 744 184 -

Ending assets 93,792 91,941 95,194 97,613 100,447 103,379 106,413 109,553 83,157 97,613 109,553

Net flows $1,303 $622 $762 $836 $1,214 $1,264 $1,316 $1,371 $5,029 $3,524 $5,166

Market action $9,332 ($2,474) $2,491 $1,583 $1,620 $1,668 $1,718 $1,769 ($5,545) $10,932 $6,774

Average AuM Equity Funds $73,585 $75,188 $75,244 $77,374 $79,378 $81,741 $84,179 $86,695 $69,411 $72,889 $83,093

Average AuM Fixed Income Funds 14,964 16,196 16,896 17,656 18,313 18,847 19,406 19,991 12,445 16,063 19,207

Average AuM Money Market Funds 1,541 1,483 1,427 1,373 1,340 1,326 1,311 1,297 1,108 981 831

Average total AuM $90,090 $92,866 $93,567 $96,404 $99,030 $101,913 $104,896 $107,983 $82,963 $89,933 $103,131

Average AuM Advisory Channel $34,010 $34,653 $34,631 $35,278 $35,838 $36,466 $37,107 $37,761 $32,445 $33,618 $36,809

Average AuM Wholesale Channel 44,897 46,278 46,725 48,329 49,855 51,543 53,292 55,105 40,919 44,990 52,527

Average AuM Institutional Channel 11,184 11,935 12,211 12,796 13,338 13,905 14,497 15,116 10,052 11,777 14,247

Average total AuM $90,090 $92,866 $93,567 $96,404 $99,030 $101,913 $104,896 $107,983 $83,415 $90,385 $103,583

AuM as % of Total 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Average AuM Equity Funds 81.7% 81.0% 80.4% 80.3% 80.2% 80.2% 80.3% 80.3% 83.7% 81.0% 80.6%

Average AuM Fixed Income Funds 16.6% 17.4% 18.1% 18.3% 18.5% 18.5% 18.5% 18.5% 15.0% 17.9% 18.6%

Average AuM Money Market Funds 1.7% 1.6% 1.5% 1.4% 1.4% 1.3% 1.3% 1.2% 1.3% 1.1% 0.8%

AuM as % of Total

Average AuM Advisory Channel 37.8% 37.3% 37.0% 36.6% 36.2% 35.8% 35.4% 35.0% 39.1% 37.4% 35.7%

Average AuM Wholesale Channel 49.8% 49.8% 49.9% 50.1% 50.3% 50.6% 50.8% 51.0% 49.3% 50.0% 50.9%

Average AuM Institutional Channel 12.4% 12.9% 13.1% 13.3% 13.5% 13.6% 13.8% 14.0% 12.1% 13.1% 13.8%

Performance

Operating income margins - gross 23.7% 23.4% 23.3% 23.0% 24.0% 24.3% 24.3% 23.8% 24.4% 23.3% 24.1%

Pre-tax margins - gross 24.1% 23.8% 23.7% 23.3% 24.4% 24.7% 24.6% 24.1% 23.7% 23.7% 24.4%

After-tax margins - gross 15.5% 14.8% 14.8% 14.6% 15.2% 15.4% 15.4% 15.1% 14.7% 14.9% 15.3%

Operating income margins - net 30.2% 30.0% 29.6% 29.5% 31.1% 31.5% 31.2% 30.9% 31.4% 29.8% 31.2%

Pre-tax margins - net 30.7% 30.5% 30.1% 30.0% 31.6% 31.9% 31.6% 31.3% 30.4% 30.3% 31.6%

After-tax margins - net 19.7% 19.0% 18.8% 18.7% 19.7% 20.0% 19.8% 19.6% 18.9% 19.1% 19.8%

Compensation expense ratio 14.8% 14.0% 13.5% 14.2% 13.5% 13.5% 13.5% 14.2% 13.5% 14.1% 13.7%

Non-compensation expense ratio 61.5% 62.6% 63.2% 62.8% 62.5% 62.2% 62.2% 62.0% 62.1% 62.6% 62.2%

Expense ratio 76.3% 76.6% 76.7% 77.0% 76.0% 75.7% 75.7% 76.2% 75.6% 76.7% 75.9%

Number of advisors 1,778 - - - - - - - - - -

Gross revenue per advisor ($ in '000) $40.8 - - - - - - - - - -

Number of shareholder accounts (in '000) 4,082 - - - - - - - - - -

Number of shareholders (in '000) 832 - - - - - - - - - -

2013

2012E 2013E

2012


36

Required Disclosures

Conflicts Disclosures

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including totalrevenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated byinvestment banking activities of the member companies of RBC Capital Markets and its affiliates.

RBC Capital Markets, LLC makes a market in the securities of Waddell & Reed Financial, Inc. and may act as principal with regard tosales or purchases of this security.

A member company of RBC Capital Markets or one of its affiliates received compensation for products or services other thaninvestment banking services from Waddell & Reed Financial, Inc. during the past 12 months. During this time, a member company ofRBC Capital Markets or one of its affiliates provided non-securities services to Waddell & Reed Financial, Inc..

RBC Capital Markets has provided Waddell & Reed Financial, Inc. with non-securities services in the past 12 months.

The author is employed by RBC Capital Markets, LLC, a securities broker-dealer with principal offices located in New York, USA.

Explanation of RBC Capital Markets Equity Rating System

An analyst's 'sector' is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned toa particular stock represents solely the analyst's view of how that stock will perform over the next 12 months relative to the analyst'ssector average.RatingsTop Pick (TP): Represents analyst's best idea in the sector; expected to provide significant absolute total return over 12 months with afavorable risk-reward ratio.Outperform (O): Expected to materially outperform sector average over 12 months.Sector Perform (SP): Returns expected to be in line with sector average over 12 months.Underperform (U): Returns expected to be materially below sector average over 12 months.Risk Qualifiers (any of the following criteria may be present):Average Risk (Avg): Volatility and risk expected to be comparable to sector; average revenue and earnings predictability; nosignificant cash flow/financing concerns over coming 12-24 months; fairly liquid.Above Average Risk (AA): Volatility and risk expected to be above sector; below average revenue and earnings predictability; maynot be suitable for a significant class of individual equity investors; may have negative cash flow; low market cap or float.Speculative (Spec): Risk consistent with venture capital; low public float; potential balance sheet concerns; risk of being delisted.

Distribution of Ratings

For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy,Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick/Outperform,Sector Perform and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the samebecause our ratings are determined on a relative basis (as described above).

Distribution of RatingsRBC Capital Markets, Equity Research

Investment BankingServ./Past 12 Mos.

Rating Count Percent Count Percent

BUY[TP/O] 775 52.36 224 28.90HOLD[SP] 638 43.11 152 23.82SELL[U] 67 4.53 2 2.99


37

Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q316

24

32

40

48

2010 2011 2012

Rating and Price Target History for: Waddell & Reed Financial, Inc. as of 07-23-2012 (in USD)

Legend:

TP: Top Pick; O: Outperform; SP: Sector Perform; U: Underperform; I: Initiation of Research Coverage; D: Discontinuation of Research Coverage; NR: Not Rated; NA: Not Available;

RL: Recommended List - RL: On: Refers to date a security was placed on a recommended list, while RL Off: Refers to date a security was removed from a recommended list.

Created by BlueMatrix

References to a Recommended List in the recommendation history chart may include one or more recommended lists or modelportfolios maintained by a business unit of the Wealth Management Division of RBC Capital Markets, LLC. These RecommendedLists include a former list called the Prime Opportunity List (RL 3), the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio:Large Cap (RL 7), Guided Portfolio: Dividend Growth (RL 8), the Guided Portfolio: Midcap 111 (RL9), and the Guided Portfolio:ADR (RL 10). The abbreviation 'RL On' means the date a security was placed on a Recommended List. The abbreviation 'RL Off'means the date a security was removed from a Recommended List.

Conflicts Policy

RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. Toaccess our current policy, clients should refer tohttps://www.rbccm.com/global/file-414164.pdfor send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower,Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.

Dissemination of Research and Short-Term Trade Ideas

RBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having regardto local time zones in overseas jurisdictions. RBC Capital Markets' research is posted to our proprietary websites to ensure eligibleclients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additional distribution may bedone by the sales personnel via email, fax or regular mail. Clients may also receive our research via third-party vendors. Please contactyour investment advisor or institutional salesperson for more information regarding RBC Capital Markets' research. RBC CapitalMarkets also provides eligible clients with access to SPARC on its proprietary INSIGHT website. SPARC contains market color andcommentary, and may also contain Short-Term Trade Ideas regarding the securities of subject companies discussed in this or otherresearch reports. SPARC may be accessed via the following hyperlink: https://www.rbcinsight.com. A Short-Term Trade Idea reflectsthe research analyst's directional view regarding the price of the security of a subject company in the coming days or weeks, based onmarket and trading events. A Short-Term Trade Idea may differ from the price targets and/or recommendations in our publishedresearch reports reflecting the research analyst's views of the longer-term (one year) prospects of the subject company, as a result ofthe differing time horizons, methodologies and/or other factors. Thus, it is possible that the security of a subject company that isconsidered a long-term 'Sector Perform' or even an 'Underperform' might be a short-term buying opportunity as a result of temporaryselling pressure in the market; conversely, the security of a subject company that is rated a long-term 'Outperform' could be consideredsusceptible to a short-term downward price correction. Short-Term Trade Ideas are not ratings, nor are they part of any ratings system,and RBC Capital Markets generally does not intend, nor undertakes any obligation, to maintain or update Short-Term Trade Ideas.Short-Term Trade Ideas discussed in SPARC may not be suitable for all investors and have not been tailored to individual investorcircumstances and objectives, and investors should make their own independent decisions regarding any Short-Term Trade Ideasdiscussed therein.

Analyst Certification

All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of thesubject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly orindirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.


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38

The Global Industry Classification Standard (“GICS”) was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor’s Financial ServicesLLC (“S&P”) and is licensed for use by RBC. Neither MSCI, S&P, nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or impliedwarranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties oforiginality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no eventshall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive,consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

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