Perpetual (ASX: PPT) is one of Australia's oldest financial services firms and offers services including funds management, portfolio management, financial planning, trustee, responsible entity and compliance services, executor services, investment administration and custody services.

Despite the lineage, Perpetual has fallen out of favour with investors as the share price has dropped more than 16% this year. Morningstar analyst Shaun Ler believes investors are being shortsighted.

The shares trade around 25% below Ler’s revised fair value estimate of $27.50 per share. He lowered his fair value from $30.50 previously on reduced projected base fee margins in the asset management business.

However, Ler does see reasons for optimism. In his base case, asset management outflows should moderate starting late fiscal 2024, with operating margins improving compared with fiscal 2023.

In a bullish scenario, asset management outflows could ease by the end of first-half fiscal 2024.

In a bear case, asset management outflows keep persisting at mid-single-digit rates and profit margins decline further.

PPT

Reasons for optimism on fund flows

Ler points to several reasons for optimism that outflows will moderate and reverse. These include:

Good performance: Solid performance in asset management, which accounts for 51% of our fair value estimate, should slow and gradually reverse redemptions. Most funds are outperforming benchmarks, justifying their value-add over passive investments. They also alleviate concerns on team stability after the merger with Pendal. Most strategies are also outperforming peers. This boosts the odds of winning new mandates, being included in model portfolios, and/or obtaining favorable fund ratings.

Recovery in industry flows: The current sluggish flows are likely cyclical. Heightened volatility primarily drove net outflows. This headwind should moderate with renewed investor appetite for listed assets beyond just cash, particularly as rate hikes peak. Perpetual’s equities and fixed-income products saw redemptions in line with industry trends over the last 12 months to September 2023. Sound performance should help moderate outflows when industry flows normalize. Ler notes that Perpetual's Australian Equity strategies have experienced net outflows drop to high-single-digit rates since June 2022, down from an average of 21% between June 2019 and June 2021, following strong outperformance in 2021-22.

Adviser and economic stability will contribute to flows: Perpetual Private, which makes up 20% of Ler’s fair value estimate, is well-positioned for a quicker and smoother flow recovery than peers. The postpandemic asset price surge drove robust growth in high-net-worth client flows for Perpetual. However, this has become more volatile after interest rates rose consecutively starting mid-2022. Ler expects a rebound in macroeconomic conditions to enable greater client inflows. Perpetual’s growing adviser proportion relative to the industry total positions should attract steadier client flows, versus major peers that face adviser losses. Perpetual’s diverse range of services and clean regulatory track record support this advantage.

Mortgage growth benefits corporate trust division: Concerns on the corporate trust division’s slowing growth are overblown, as the slowdown is likely cyclical. This is because maintainable earnings are tied to enduring factors like loan growth and capital flows into Australia. An eventual fade in economic uncertainty is likely to drive stronger loan and investment volumes. In turn, Perpetual’s intangible brand and cost advantage should allow for a substantial share of this volume growth. Corporate trust makes up 29% of Ler’s fair value estimate.

Ler's full share pitch on Perpetual is available to Morningstar Investor subscribers here.