Funds management businesses
A short look at the asset management sector.
By and large, asset management companies are high quality.
That’s because they typically have no debt (it’s all other people’s money) and very little by way of capex or opex, other than a few computers and the odd superstar stockpicker. Capital light business produce good returns and minimal expenses mean good margins.
You can safely ignore Netwealth in the below graphical output of our quant factor scores, here sorted by industry. We are more interested in the genuine investment management vehicles, like MFG, JHG, PTM etc.
Net income / FUM
They are also quite easy to model. Take their funds under management (FUM) multiplied by the fees they charge, and you’ve more or less solved for NPAT, on which you can then place a multiple.
Those FUM balances have grown handsomely, given the very generous legislative backdrop to super in Australia, which is, I think, something everyone reading this note knows and knows well. Spare a thought for Perpetual, perhaps.
IOOF’s recent FUM increase represents acquisitions (as the big 4 banks step back from vertically integrated capabilities) but the general industry point stands.
You might imagine that the increased scale, and a presumably competitive environment might result in some reduction in fees across the space.
But, for the major listed, not so. A broader, encompassing measure of fee related revenues to funds under advice/funds under management shows no downtrends…
…and nor does a more narrow definition of investment management fees. Note that each manager has a different product mix (some are multi-asset managers, with large fixed income books which are typically much lower fees, and some have markedly different distribution channels (e.g. institutional, retail, wholesale, not-for-profit, etc.).
But, whatever the business, the FUM and the competitive landscape haven’t dented the fee structures by as much as you might have first imagined.
The main threat comes from years of underperformance relative to benchmark, for the industry as a whole, and the associated shift into passive and smart beta funds.
That flow out of active has been the main constraint on profit growth.
Role in a portfolio
So, we’ve got stocks that are pretty straightforward to model in theory (FUM x Fees), but, you have to guess the FUM, which means guessing market movements and estimating the product mix and propensity for outperformance. And, even if you get those right, you might still have an avalanche of flow going against you, if, for whatever reason, the market is against that manager’s style.
Or, you can be AMP, and have what looks like everybody against you, regardless.
The reason you might choose to selectively add them is the operating leverage. Those minimal opex and capex outcomes means that any growth in FUM, flows or market driven, go straight to the bottom line.
As such, fund managers are just about the most correlated to market stocks you will find, outside of banks and energy. Now banks are geared beasts, and energy stocks differ markedly by profitability, so when choosing what sort of diversified mix of stocks to back in a market recovery, you might well choose to have a fund manager or two.
One last point, before concluding this short note. Below, we consider the premium relative to assets (a bit like an enterprise-value to resources metric, for BHP, or a price to NTA for a REIT).
Here we look at the market cap of the company, minus whatever tangible equity there is, and express over the assets under management.
The key is to note the Aussie Ethical fund. People are very keen to give them money, as keen as they are to support ESG ideals. That’s great, but, it certainly raises the prospect of an “ESG” bubble, where emotion and exuberance has gotten ahead of valuation.
The corollary of that is it probably suggests that “sin” stocks, might be undervalued. We are overweight WPL in our direct equity portfolios.
As discussed in our note yesterday, we think the global market narrative is very finely balanced. There are plenty of reasons to be very optimistic, and plenty of reason for caution. That doesn’t happen all that often, usually the “side-of-the-fence” to sit on is pretty clear to us.
What is clearer, perhaps, is our view that the Australian equity market is more vulnerable to a correction than international markets, and more vulnerable to a downturn in the economy given the ill-balanced nature of our growth, and economic composition.
As such, owning stocks with a high degree of operating leverage to further runs in the Aussie market is less compelling to us (noting that many of these managers do have a high degree of exposure to other currencies, which are still in general swamped by the macro factor influence of the local market, and then secondly the performance of the industry group).
Still, when you are looking for quality, and don’t want the banks, insurers or the ASX itself within the financials and diversified financials sphere, some of these names do fit the bill.
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