Matt Snowling does not like what he sees developing at Waddell & Reed. The stock an analyst at FBR Capital Markets came out with a research report Wednesday in which he downgraded Waddell's stock to a market perform and lowered his target for the share price to $32 a share from $42.

The problem: Waddell & Reed is dependent on one mutual fund -- Asset Strategy -- for a bulk of its new sales.

Snowling notes that the fund makes up "the majority" of W&R's mutual fund sales and that the "risk and possibility of client outflows from that product are enough to put us on the sidelines..."

W&R offers the fund both under its own brand (UNASX) and through its Ivy brand (WASAX). Together the two funds hold some $23.3 billion in AUM, according to Morningstar. Snowling's report pegs the AUM in the fund at $26.7 billion.

The pool of assets carries a 57 basis point management fee, meaning it will generate roughly $150 million annually in management fees alone. The total expense ratio on the funds runs from 103 basis points and up depending on the share class.

How important is that $150 million in revenue to Waddell & Reed? Snowling expects the brokerage firm and fund manager to generate $450 million in revenue for all of 2010; so the fund represents up to one-third of Waddell's top line.

Snowling points out that it also accounts for nearly one-third (30 percent) of the firm's fund AUM and nearly 85 percent of its net fund flows.

Those flows could slow down as the Asset Strategy fund hits a stretch of tough performance, worries Snowling. Year-to-date the fund is off 9.7 percent, leaving it well behind the S&P 500 (which is off 3.0 percent). He notes that the fund has also lagged the index since the May 6 "flash crash"; trailing the S&P 500 by 60 basis points (a 4.7 percent loss for the benchmark and to 5.3 percent for the fund).

He believes that the lagging performance may already be creating outflows from the fund, though he has no hard data from after March, when the fund pulled in nearly $500 million in net new assets an amount in line with its track record over the past year.

The last time the fund saw negative performance was in the fall 2008 market meltdown. During that period, net inflows dropped from nearly $1 billion per month to outflows in excess of $500 million per month from October until December.

Interestingly, Snowling does not raise the possibility that fallout from the flash crash could harm the fund's reputation. It was trades made by the Asset Strategies fund that some believe contributed to the panic during the flash crash and its trades during that time are being reviewed by the Chicago Mercantile Exchange.

That past history is what worries Snowling, but the track record also shows that the picture could change quickly if the fund rebounds.

"If the losses are short-lived and the fund can bounce back, we believe investors are likely to return and the company will be able to regain its growth momentum fairly quickly." 

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