Financial service stocks on sale amid sector sell-off
Analysts believe the asset manager sell-off overlooks some of the attractive traits of businesses like Magellan, Platinum and Pendal.
A downturn in equity markets has seen a range of Australian asset managers and financial services companies fall into undervalued territory.
Shares of listed investment managers including Magellan Financial Group (ASX: MFG), Platinum Asset Management (ASX: PTM) and Pendal Group (ASX: PDL) have fallen to 52-week lows amid a bout of volatility and global equity market weakness.
Morningstar equity analyst Shaun Ler believes the market is underestimating the key investment strategies of these asset managers, and their ability to deliver index-beating returns and attract new money.
“We think the outlook for asset managers is better than what's currently being priced in,” he says in a new special report on Australia’s funds management industry.
“Recent market declines suggest future investment returns will likely improve. Their strong fundamentals, such as having solid operating cash flows and relatively low capital intensity support our conviction.”
Part of Ler’s reasoning rests on Morningstar’s bullish view on global equity market. Analysts say global stocks are undervalued and expect earnings to grow strongly. As such, Ler expects global equity fund manager returns and earnings to grow meaningfully.
“Based on Morningstar's assessment, global stocks are already undervalued on aggregate,” he says.
“This suggests if a constant multiple is applied on higher future earnings, higher share prices (and potentially equity markets) are likely. This bodes well for asset managers who mainly derive revenue by earning a cut of funds under management.”
Morningstar’s report follows a torrid time for Australia’s listed asset managers. Some, most notably investment distributor Pinnacle, saw their share prices rocket up in the year following the Covid-19 market bounce. But shares have since come off, Pinnacle falling 33% this year, as the market sours on the sector.
Others never had a sustained bounce. Shares in embattled global equity stalwart Magellan rebounded in March 2020 but have headed in one direction since August that year – down. From a peak of $65 in August 2020 to around $15 today, Magellan shareholders have suffered the loss of a key institutional mandate, the departure of its star manager Hamish Douglass on indefinite medical leave and more than 10 billion in outflows. In 2020, the wildly popular flagship Global equity fund notched its worst year in a decade, delivering investors a negative return (-0.2%), hampered by a big bet on Chinese e-commerce giant Alibaba; energy sector exposure; and a dash for cash in the March-downturn.
Growth 10k since March 2020 | Magellan, Platinum, Pinnacle, Pendal, Perpetual
Click to enlarge. Source: Morningstar
Pain too has been felt among the ASX-listed payment providers and consumer financing services Zip Co (ASX: Z1P), Humm Group (ASX: HUM) and EML Payments (ASX: EML). After technology pushed the market higher for years, the threat of rising interest rates has taken the shine off this sector, with investors less willing to pay high multiples for growth.
Best buys
Among Ler’s top picks in the asset management sector are Magellan Financial Group (ASX: MFG), Pinnacle (ASX: PNI), global investment managers Platinum (ASX: PTM) and Pendal (ASX: PDL) – all trading at substantial discounts.
He says current share prices suggest the market is “pricing an average net profit after tax decline of 6% per year for these firms over the next five years”. For this to occur, he estimates that each would need to deliver below-index returns, and most continue to bleed outflows – an outcome he described as “unlikely”.
“Many key holdings of the biggest strategies of these four asset managers fell materially below Morningstar’s intrinsic assessment,” Ler says.
“This means there is a higher probability for these strategies to deliver above market returns. If this happens as we would expect, it will likely help relative performance and assist with winning new money.”
On Magellan, Ler thinks the market is underestimating the capacity of its flagship Global Equity fund to outperform. He notes that many of the fund’s key stock holdings are undervalued in Morningstar’s analyst’s eyes and are expected to rebound. He also applauds Magellan’s efforts to push its better-performing strategies to mitigate overall outflows and promote its investment team, which he says assuages key person risk.
The market is similarly overlooking the firms operating under the Pinnacle brand, Ler says, including growth manager Hyperion and global equity manager Antipodes. Winning bets, including Tesla, led to outperformance for Hyperion’s Global Growth Active ETF (HYGG) in 2020 and 2021. Investor money followed. But performance has struggled recently, falling -15.47 this year, as growth stocks have tumbled.
“We believe Pinnacle can continue gaining market share from competitors,” Ler says.
“Pinnacle affiliates are highly competitive, both in performance and fees. It has an expanding product suite that can be tailored to suit varying market conditions. Operating leverage is strengthening as funds under management grows.”
Finally, Ler says Pendal’s recent strong outperformance will support future mandate wins and flows of new money. However, he says the firm is more vulnerable to outflows from institutional rebalancing and/or platform consolidation than a manager like Pinnacle.
Ahead, Ler believes capital initiatives like share buybacks could boost share prices. Shareholders should cheer if companies can buy back their own shares at a discount. Reducing the number of shares boosts earnings and dividends for the remaining shareholders. Magellan has just announced a share buyback representing up to 5.4% of its shares on issue, triggering a share price rally, and Ler expects others, like Platinum, to follow.
“We think this reflects the relative cheapness of the shares and a lever for listed managers to boost shareholder returns,” he says.