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One of the more surprising things I find with investors is the keen interest to invest in fund managers. Not investing in the investment funds themselves, but the business of being a fund manager.
Surprising because in the scheme of things, it is a relatively small and arguably inconsequential industry. Surprising because the industry faces headwinds, there are very low barriers to entry from new competitors, and as you get bigger and scale up, it can actually get harder.
On the headwinds side, competition (in particular from very low-cost index funds) means that there is ongoing pressure for lower fund management fees. Plus, increasing regulation means that compliance costs are increasing. Because it is a capital light business, there are no physical assets, and timeframes to establish a new business are relatively short, the barriers to entry for new competitors aren’t that high. And if your “star” stock picker think they can do it under their own banner and leaves, you immediately have a crisis on your hands.
And in the Australian context, the bigger you get, the harder it becomes because our market is concentrated and liquidity away from the top 20 to 50 stocks dries up quickly. Whereas you might be able to “outperform” with a $1 billion fund, when it gets to $5 billion, it becomes more difficult. That is one of the reasons there is a dearth of actively managed Australian equity funds – it is hard to outperform – and several of the investment managers focus on global equities because the size issue is less of a constraint.
Ultimately, running a successful funds management business is about two things – performance and distribution. Performance ultimately drives distribution success, but you do need to have the relationship and selling skills to win mandates from the institutional investors (super funds etc) and have the financial planners include your funds on their “recommended product lists”.
Magellan Financial Group (MFG) had until a few years ago done both brilliantly. Its demise is, however, ultimately a story about performance – that is, underperformance.
It has also shot itself in the foot over a couple of issues. For some reason, it invested outside its key mandate area, taking a major stake in unlisted fast-food chain Guzman y Gomez and bankrolling investment bank Barrenjoey. The latter is of course a competitor to the major stockbroking houses – Macquarie, Credit Suisse, Citi, Morgan Stanley, JP Morgan, UBS etc – and they haven’t been too keen to support Magellan in its ”hour of need”. There is no love lost in investment banking.
With retail investors, the rationalisation of Magellan’s retail funds into two ASX listed funds, one with ‘open class’ units and the other with ‘closed class’ units, looked logical. It gave investors a reason to invest more funds into ‘closed class’ units, offering them a discount of 7.5% to the Net Asset Value (with the discount to be paid by Magellan Financial Group). What it forgot to tell investors was the reason (closed class units are in a fund manager valuation sense worth considerably more than open class units), and investors have watched the discount deteriorate to about 16%.
Hamish Douglass’s separation from his partner and ultimate resignation from the Board, the sudden resignation of CEO Brett Cairns, and the loss of Magellan’s largest institutional client St James’s Place, which contributed approximately 12% of Magellan’s revenues, each placed downward pressure on the share price.
Magellan’s “falling knife” looks like this:
A stock price chart of Magellan Financial Group (MFG).
On the performance side, its flagship Global Equity Fund underperformed in February. The retail version, the Magellan Global Fund (Open Class) (MGOC), lost 7.2% compared to the benchmark MSCI World Net Total Return Index (AUD) loss of 5.4%. It has underperformed across all time periods out to 10 years. However, since its inception in 2007, it boasts an average return of 11.1% pa, outperforming the index by an average of 3.6% pa.
Funds outflow is a consequence of poor investment performance and will continue until investment performance improves. On 14 March, Magellan reported net outflows of approximately $5.0 billion since the most recent update on 25 February. This took its FUM (funds under management) to $69.1 billion. This caught the market a little by surprise – but I am not sure what they were expecting because for as long as Magellan continues to underperform, there will be pressure to withdraw funds. Another report is due around 14 April – this is also likely to show funds outflow.
The major brokers are bearish on Magellan, with 4 ‘sell’ recommendations and 2 ‘neutral’ recommendations. Since the middle of February, each has reduced its target price. On consensus, this now sits at $13.51, approximately a 5% discount to Friday’s ASX close of $14.20. The range is tight – from a low of $12 through to a high of $15.78.
The brokers’ major concern is further funds outflow, leading to a compression of FY23 earnings. They have Magellan trading at a multiple of just 6.4x forecast FY22 earnings but expect earnings per share to fall by 35.2% in FY23. The multiple for this year is an attractive 9.9x.
There is no doubt Magellan is super cheap on all the metrics, including a fantastic dividend yield (on a $14.20 share price, 13.2% prospective for this year, 8.7% forecast for FY23). The return of Chris Mackay as Chief Investment Officer is a good move and should steady the ship.
But there is no sign yet that the stock has bottomed.
It may have, but only time will tell. On the ‘bad news’ front, another funds under management report will be published in the second week of April and there will also be an update on investment performance. Both are unlikely to be overly positive.
For me, Magellan is a relatively simple proposition. It will be a “buy” when the investment performance starts to improve. Until then, watch and wait. Thrillseekers may want to get in earlier, but my caution would be to not use all your firepower.
All prices and analysis at 28 March 2022. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.