Platinum and Magellan: Is there value in underperforming listed investment managers?
Analysts believe near-term turbulence is not reflective of future earnings potential.
Mentioned: Magellan Global Open Class (15699), Platinum International Fund (4505), Platinum Asia (9894), Magellan Financial Group Ltd (MFG), Pinnacle Investment Management Group Ltd (PNI), Perpetual Ltd (PPT), Platinum Asset Management Ltd (PTM)
Australia's listed-global equity managers have had a year to forget. Magellan's flagship global fund provided good downside protection during the initial covid-19 selloff, but the market's swift rebound and the Alibaba sell-off caught the manager off-guard. Magellan Global returned 10.77% in fiscal 2021. Meanwhile, the MSCI World index raced ahead adding 27.52%. At Platinum, its global strategy lagged its peer group in the first three quarters of 2020, although the fund rebounded strongly in the fourth. However, long-term trailing returns have taken a beating.
The upshot: Magellan Financial Group's (ASX: MFG) underlying profit fell 6% to $412 million. Morningstar equity analyst Shaun Ler says profits were weighed by a 63% drop in performance fees, due to underperformance, and start-up costs for investment bank Barrenjoey. Investors didn't take the news well, sending Magellan shares down more than 10% on the day of the result.
Magellan saw $351 million in net outflows in the June quarter. While this is a drop in the ocean for the $113 billion fund manager, it signals disquiet among some investors.
At Platinum Asset Management (ASX: PTM), profits were down $163 million, below fiscal 2016's $200 million – demonstrating flat earnings over the last five years. Ler attributes this to persistent net outflows and growing expenses amid industry-wide fee compression. This saw the cost to income ratio climb to 26% from 18% over the same period, he says. Platinum booked net outflows every month in fiscal-2021.
Among those to deliver 'good' news last month were diversified manager Perpetual (ASX: PPT). Profit was up 26% to $124 million and funds under management (FUM) up 236% from the year prior, driven largely by the acquisition of Barrow Hanley and Trillium and strong market returns, Ler says.
"All funds in its Australian investment business, previously an underperformer, beat benchmarks over the year to June 30."
Boutique fund incubator Pinnacle (ASX: PNI) similarly impressed with both FUM and profit growing at a four-year compound annual growth rate of 40% and 50%, respectively. The firm ended fiscal 2021 with record net inflows and greater diversification in strategies, clients and fees, Ler notes.
The question for equity investors is whether Magellan and Platinum can outperform their benchmarks in the future, and are therefore trading at bargain prices today.
Economic moat intact
Ler cut Magellan's fair value to $55.50 per share (from $56.50) following the result. However, he believes shares are undervalued saying there's room for growth in Magellan's newer products as it ramps up distribution.
"We see greater prospects of earnings growth from several avenues," he says.
"First, mean-reversion in equity markets that should help deliver greater future returns, revive stronger inflows, and boost performance fees.
"Second, a cleverly designed product suite allowing it to capitalise on emerging investor preferences--namely the need for retirement income, allocation to passive and the popularity of ESG investing.
"Third, earnings upside as its principal investments--notably Barrenjoey, Guzman y Gomez, and FinClear--turns profitable."
Magellan fund holders have historically demonstrated deep loyalty. The manager had only two months of net outflows in 2016-17 following subpar performance in calendar 2016. This, Ler says, is illustrative of Magellan's narrow economic moat, underpinned by brand.
Ler's valuation assumes Magellan will deliver returns averaging 9% over the next five years, below an average of 12% per year over the last three years. He notes the top 10 holdings in Magellan's Global fund are, on aggregate, fairly valued (on Morningstar's metrics), compared to broader global equities which are close to 10% overvalued.
"The prospects of economic recovery from vaccination rollouts--which led to the rebound of cyclical stocks that scarred Magellan's relative performance--are now more than priced in, with cyclicals, on average, 5% more overvalued than defensives," he says.
Holdings undervalued
On Platinum's potential for outperformance, Ler is uncertain. Its flagship fund, Platinum International, has underperformed the MSCI World Ex Australia NR index over 3, 5 and 10-year periods. Platinum Asia has an impressive long-term track record, demonstrating consistent outperformance. However, the fund recently lost its portfolio manager, lowering Morningstar analysts' confidence.
Ler lowered Platinum's fair value to $4.25 (from $4.40) following the result on lower forecast net inflows. Today, shares are fairly valued.
Like Magellan, Ler suggests there is potential for Platinum to deliver greater returns.
"We don't know (if Platinum can outperform moving forward) for certain," he says. "What we believe, however, is that it can deliver returns exceeding its 3-year average of 9% in the future and this stronger performance should correspondingly revive net inflows in fiscal 2023."
"We calculate the top 10 holdings in Platinum International and Platinum Asia--both of which drive the bulk of group FUM--are on average 8% and 16% undervalued, respectively. In contrast, the broader global equities asset class are more than 6% overvalued. The greater the undervaluation, the greater the potential for price appreciation (and vice versa).
"And not to forget is that most of its other strategies, for example, Healthcare and International Brands) continue to outperform over a trailing one-year period."
Platinum International has begun to show short-term signs of recovery as long-term exposure to semiconductors and resources has paid off handsomely over the six months to 31 March 2021.
On the upside, Ler applauds Platinum's increased focus on product enhancements and client engagement, and its decision to follow Magellan into the retirement market via its Platinum Investment Bond and Fixed Cash Distribution Option (set at 4%).
"These products appear simpler than Magellan FuturePay, and it will be down to Platinum to promote them via greater client engagements," he says.
"It is an area Platinum has also been doubling down on in recent times, as evidenced by its increased webinars, social media campaigns and virtual/in-person meetings."