Magellan's (ASX: MFG) interim profit growth was like an oasis in the desert, amid the deluge of negative headlines. The investment manager announced 16% interim underlying NPAT growth from the prior period to $248 million on Friday. But ongoing redemptions would lower the compounding effect of funds under management. This is likely to coincide with an uptick in costs to retain staff, distribute its products and engage with clients. As such, we anticipate NPAT to fall over the next two years to a low of $389 million by fiscal 2024. We see this rebounding fiscal 2026 as fund performance improves and outflows moderate in outer years.

Magellan is for the patient investor. For shares to re-rate, Magellan Global needs to outperform. We are confident this will happen over the medium term, as markets currently remain in correction amid expectations of rising rates. No client engagement can save the current prolonged underperformance by Magellan Global, however, so we expect redemptions to persist in the near term. 

We lower our fair value estimate after increasing our net outflow and cost forecasts, partly offset by stronger earnings for principal investments (mainly Barrenjoey) and slower fee compression. We assume net outflows of $64 billion from fiscal 2022-26. This means, excluding St James Place, we assume $41 billion more net outflows—$13 billion retail (44% of February 9's retail funds under management), $28 billion institutional (slightly above our funds under management estimate for its top 5 largest clients).

Magellan's near-term initiatives could partly mitigate net outflows. In upcoming periods, the firm will parade its investment team as it attempts to assuage key person risks and retain its clients. It will also sell its Infrastructure/Australian equities funds, low-cost ETFs, ESG products, and FuturePay more aggressively. These products are new or were outshadowed by Magellan Global, so any initiatives here would support flows. More client and investor communication provide an opportunity for Magellan to diffuse prevailing negative perceptions and restore its brand.

Regardless, investors should brace for a bumpy recovery. For example, the de-rating of Magellan funds by certain research houses/asset consultants could remove Magellan's products from model portfolios. Advisers are not beholden to fund ratings and can pull money from Magellan so long as they can justify it as being in clients' best interests.  Douglass was the cornerstone of many clients' investing decision, and not all may wait for Chris Mackay and Nikki Thomas to turnaround the Global portfolio. Magellan's resistance to cut fees, or create client-friendly (but less lucrative) products like performance-fee-based funds or managed accounts is also hampering fund inflows/retention.

We expect dividends per share, paid from funds management earnings, to fall over the next three years to about $1.60 by fiscal 2024 (from $2.11 in fiscal 2021), before recovering by fiscal 2026. 

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