A revised version of teh Asset Manager Pulse was released on 12 April 2024. This article has been amended with the additional and revised information.

Share prices of the ASX-listed asset managers fell for most of 2023 but broadly rebounded late in the year in anticipation of lower interest rates and better fund flows. Fund flows improved from the fourth quarter as investors shifted from defensive money market funds or cash to traditional assets such as equities and fixed interest.

The risk is if inflation proves sticky and further rate hikes are needed. This would likely raise investor concerns, make cash more attractive, and weigh on sentiment.

Share prices of ASX-listed asset managers fell through most of 2023 but broadly rebounded late in the year, anticipating lower interest rates. Stabilising rates generally enhance investor risk appetite, thus boosting fund flows, asset prices, and earnings for asset managers. Long-term issues include fee compression, wage inflation, and the need for business development investment.

Globally, net annual fund flows into open-ended, money market, and exchange-traded funds turned positive in March 2023 after close to six months of net outflows. We think this reflects an increased likelihood of rate cuts in 2024. In Australia, the prospect of cuts is likely positive for flows into Australian-domiciled funds, including ETFs, industry funds, and active managers.

All are headwinds for profit margins. The shift to passively managed investments is structural and active managers are increasingly reliant on market gains for asset growth.
Share prices for the ASX-listed asset managers fell on average by 4% in 2023, underperforming the ASX 200 TR and Morningstar Australia TR indexes, up 12% and 13%, respectively, by more than 15%.

GQG, Magellan, Perpetual, and Pinnacle rose, while Challenger, Platinum, and Insignia all fell. The cohort's average price/fair value increased to 0.85 by December 2023 from 0.72 in January 2023. As of March 10, 2024, the average price/fair value multiple is 0.91. They may rerate higher if inflation slows or declines and rate hikes cease or are even cut. Rising share prices since the last quarter of 2023 are the main factor driving convergence toward our fair value estimates.

However, significant reductions in fair value estimates for Magellan and Platinum also played a role. With an average price/fair value ratio of 0.78, Insignia and Perpetual offer the greatest relative value. We think the market underestimates flows and the potential value from cost cuts for both these firms.

A revised version of the Asset Manager Pulse (released 12 April 2024) outlines the lowering of the fair value estimate for no-moat-rated Platinum Asset Management in a research report published on March 28, 2024. This reflects worse-than-expected fund outflows, reported by Platinum on March 26, 2024, and the commensurate reduction to future revenue the outflows imply. We have updated our Industry Pulse report with our latest forecasts and fair value estimate for Platinum where relevant.

The full report can be found on Morningstar Investor, available to subscribers.

Our top picks

Insignia Financial (ASX: IFL)

Business strategy and outlook (at 14 March 2024)

Insignia Financial (formerly IOOF) adopts a multibrand business model. This helps it appeal to a broader set of clients and was effective in alleviating reputational damages stemming from the 2018 Royal Commission. Since then, tighter compliance and operating standards have been enforced. Insignia is also restructuring its advisor network, intending to increase the proportion of salaried advisors within its network, as this helps the firm extract higher gross margins.

Product rationalizations and fee reductions are ongoing agendas for Insignia's platform business. Insignia advisors can also recommend investments on third-party platforms due to the firm’s open architecture model. Notably, it has arrangements with third-party providers where it earns part of their administration fee for funds originated by its advisors. As competition intensifies, Insignia has responded by rationalizing its platforms and improving their functionality, helping the firm build scale to further lower the cost to customers.

Insignia's investment business manages both multimanager and direct investment funds.
Mergers and acquisitions have been Insignia's major focus, driving efficiencies through economies of scale and removal of duplicated back-office functions, while also allowing the firm to sell its own products to new clients.

Insignia has several near-term headwinds to brace for. The restructuring of its advice business may lead to more advisor departures, and also deter potential new joiners. It will also take time to stem outflows, strip out costs and revive earnings growth in the acquired ANZ and MLC businesses.

Long-term earnings prospects are more positive. We don’t see Insignia suffering the same degree of brand stigma like its peers. The firm is well placed to capture a more consistent stream of inflows, especially from Australia’s growing superannuation pool.

Ongoing competition means margin pressure will persist, but this should be offset by a larger FUMA pool and scale benefits from the ANZ and MLC businesses. The transition toward having more profitable, salaried advisors will likely provide greater margin support in the future.

Moat rating

Read more about how identifying a company with a moat impacts investment results.

Insignia lacks an economic moat. We believe growth in funds under advice, administration and management, or FUMA, and positive inflows are partially byproducts of Insignia's acquisitive growth, and not just due to its branding or switching costs.

Insignia's reputation was hurt after the 2018 Royal Commission revealed the firm’s poor corporate governance. Higher industry standards, tighter legislation and more regulatory scrutiny have reduced the distributional advantages from its vertically integrated model. These changes will likely limit Insignia's inflows and pricing power.

We don’t believe Insignia's advice business has a moat. Group FUMA and advisor numbers have grown--even after the Royal Commission--but this is partly due to acquisitions. We’re not convinced it can leverage its brands to generate much stronger inflows or charge much more than competitors.

Looking ahead, we don’t foresee strong customer loyalty toward Insignia, or a high degree of stickiness between a client and an Insignia advisor. We also don’t see Insignia advisors attracting much more inflows than competitors. These are partially byproducts of increased regulatory scrutiny on wealth managers following the Royal Commission, with industry standards now tougher than before. They include more stringent requirements on advisor due diligence, education and compliance.

The Royal Commission has hurt Insignia’s image as a trusted advisor. While Insignia's multibranded advice network helped it soften the reputational hit, we don’t think having a confluence of brands will strengthen Insignia's overall reputation back to its pre-Royal Commission days. Also, the distinction between a large, established wealth manager versus a newer player--in terms of the quality of advice provided--is now less evident. This is because it’s likely that every wealth manager will focus on improving their advice and compliance standards following the Royal Commission, and the perceived benefit from engaging an Insignia advisor over other financial planners is less clear.

The perception that Insignia advisors can recommend more third-party products (via its open architecture model)--and therefore more likely to be in the clients’ best interests--is likely to fade. We expect this perception to be more generalized across the broader advisor population moving forward. This is because requirements for more transparent disclosure have made it easier to compare product features. The abolishing of grandfathered commissions and platform rebates, expanding approved product lists, and greater regulatory scrutiny will incentivize advisors industrywide--and not just within Insignia--to choose from a broader mix of products and services, and not solely recommend in-house products.

The barriers to prevent an existing/prospective Insignia advisor from leaving/joining another dealer group are low. We believe its advisor numbers are likely to reduce over the next few years. Notably, the phasing-out of grandfathered commissions and higher operating standards may prompt more advisors to leave Insignia and deter prospective joiners into the industry. A gradually shrinking advisor network narrows the distribution reach it historically possessed, potentially restricting flows into its products--weakening the benefits of vertical integration. While Insignia provides a wide variety of advisor support services, these are also offered by other established dealer groups like AMP.

We believe Insignia's platforms business does not have strong switching costs. Insignia is the largest platform provider in Australia following the MLC Wealth acquisition, competing with major financial institutions BT, AMP, and Colonial First State; and with specialty platform providers, or SPPs, like Hub24, Praemium, and Netwealth. Major financial institutions still make up around 75% of the administration platform market, but SPPs have been steadily gaining share (albeit off a low base) as they entered the market with more contemporary features than the incumbents.

However, platforms are ultimately commoditized. Any improvements in platform features are likely to be replicated, resulting in competing offerings all having very similar functionality. Insignia's modernized products like its Evolve platform--which have more investment choices and lower fees than its older products--have helped it generate consistent inflows, but not significantly more than competitors. Meanwhile, price competition will persist in this market where entry costs are low and fee disclosures are transparent.

There are mild switching costs, as changing platforms often involve administrative work and potentially tax implications. However, the switching barrier will fall further as platform technology improves. Platforms are also increasingly bearing the cost of transferring funds to their platform in order to attract funds. Enforcement of “best interest duty” rules, which require advisors to use products that are in their clients' best interests, would limit inflows via the Insignia advisor network.

Lastly, we also think Insignia's investment management business lacks intangible assets and customer switching costs associated with a high-performing fund manager. Its core investments business depends primarily on Insignia's platforms for new money. Its primary investments business is also multimanager that tailors portfolios comprising of other professionally managed funds.

Despite their low fees, multimanager funds are not exclusively offered by Insignia--Wealth managers and superannuation funds industrywide all have multimanager portfolio offerings, while investment consulting firms also provide portfolio construction services. There tends to be less dispersion of returns from such portfolios (relative to single-manager funds), and accordingly it can be difficult for Insignia to carve out a lasting intangible asset from brand name or track record.

Perpetual (ASX: PPT)

Business strategy and outlook (at 14 March 2024)

Perpetual has three business units: as an asset manager, a private wealth advisor, and a corporate trust service provider. Acquisitions form part of the group’s strategy to build scale and expand its products and services.

Product, channel, and geographic diversification is a key focus for the investments business. It is executing this by acquiring fund managers. This follows a history of pedestrian performance in its domestic investments business and its inability to grow organically.

Acquisitions of Barrow Hanley, Trillium, as well as Pendal expand its addressable market and add to its asset class offerings. Priorities include growing its distribution offshore, expanding its clientele, and broadening its product suite.

The private wealth business caters to the established wealthy, medical professionals, business owners, family offices, and aged care providers. It increases the value add to clients by providing a variety of services beyond financial planning. These capabilities are propped up by acquisitions. The Fordham acquisition is one example, where it allows Perpetual to extend accounting services to its clients. In return, its acquirees also act as referrers of new business.

The corporate trust business provides outsourced responsible entity, custodial, and trustee services to debt capital markets as well as to managed funds. Ongoing agendas include acquisitions to add scale—in the process allowing it to further lower its pricing—as well as the provision of value-added services such as data and analytic solutions to help increase the stickiness of its client base.

We believe management’s initiatives will support more maintainable earnings growth and margin stabilization. Investments in distribution and staff retention would constrain profitability, but we expect them to support improvements in net flows and revenue growth.

The moatworthy private wealth and corporate trust segments are also strong drivers of earnings growth—the former is positioned to gain market share in the domestic financial advice industry, while the latter benefits from growing securitization volume and increasing demand for outsourced responsible entity services.

Moat rating

Read more about how identifying a company with a moat impacts investment results.

On balance, we believe Perpetual has a narrow economic moat. This is premised on: (1) its wide-moat-worthy corporate trust business, which enjoys an intangible brand name, cost advantages and switching costs; (2) its narrow-moat private wealth operations, also possessing intangible assets of its brand and customer switching costs; and (3) its narrow-moat asset management business, which we believe possess an intangible brand and moderate switching costs upon the successful acquisition of Pendal Group. Our forecast earnings contribution and economic profits from the wide-moat corporate trust business aren’t substantial enough to justify a wide moat rating for the overall group.

We believe Perpetual’s corporate trust business has a wide moat. It boasts an intangible brand from its long history of providing comprehensive trustee and support services for most Australian securitization transactions since the inception of securitization in Australia in the early 1980s. The managed funds services business, too, is an established provider of corporate trustee services to fund managers and institutional investors. This history grants Perpetual strong brand recognition and deep client relationships, which in turn help retain its clientele (some of whom have been with it for 20 years) and bring in new business in a niche market where relationships matter.

Cost advantages are derived from scale. For example, the debt markets business oversees about $715 billion in FUA, roughly 4 times more than its closest competitor. The division’s large FUA pool and its largely fixed cost base--which we believe ranges between 60% and 90% of total costs, with fixed staff expenses as the majority--make it difficult for peers to match it in terms of pricing. Evidently, revenue margins (fee rates) approximate global custody businesses Northern Trust, BNY Mellon, and State Street. Moreover, there are large costs to develop/maintain software systems and processes to service such large amounts of assets, and scale makes ongoing technology spending more viable.

We also think Perpetual benefits from client stickiness. Its extensive service range--including administration, asset safekeeping, reporting, submanagement, and accounting--results in an interconnectivity between a client’s workflow and Perpetual’s infrastructure. Switching providers may subsequently disrupt a client’s work processes. In addition, the move to go beyond passively administrating assets and provide further value-added services (such as data and analytics solutions) to clients strengthens Perpetual’s relevance to clients and subsequently the perceived costs of switching.

We view the private wealth business as having a narrow moat based on switching costs as well as the intangible assets of its brand. Switching costs are generated by the breadth and relevance of wealth-management services provided to its niche clientele, typically consisting of the established wealthy, business owners, medical professionals, family offices and aged care providers. Compared with retail investors, its clients tend to be wealthier and are likely to demand more holistic advice (encompassing financial, business, tax, and estate planning).
Accordingly, Perpetual is focused on expanding the value add to its clients--beyond just financial advice--and making them less likely to switch advisors. For example, the acquisitions of Fordham, Fintuition, and Priority Life allows for cross-referral opportunities.

That is, for Perpetual to extend its services beyond traditional financial planning--to include capabilities like as accounting and risk advisory--to its existing clients, and also, for these businesses to refer clients into Perpetual. The switching costs might not be explicitly large, but the benefits of switching from one private wealth manager to another are often uncertain to clients.

Perpetual’s long history of advising and managing money for high-net-worth clients has also granted it a strong intangible brand name, which fosters greater sense of security of being its client. This perception is strengthened by (1) the fact that all its advisors are salaried employees who do not receive commissions for selling products and (2) its much lower level of vertical integration when compared with major advisor groups like AMP or Insignia Financial (formerly IOOF). Evidently, it has not suffered any major direct fallout from the 2018 Royal Commission, having seen its tenth consecutive year of net inflows as of fiscal 2023.

We also think Perpetual’s asset management business is moatworthy. Successive acquisitions of Trillium, Barrow Hanley, and Pendal add on to Perpetual’s offerings, helping it build a solid product set across a broad range of asset classes. Aside from periodic occurrences of volatility, we expect FUM to continue growing through the cycle. The diversity of funds and strategies means that when some strategies underperform, others should outperform.

Clients are able to invest between products depending on their risk appetite. Its wide range of products and strategies help appeal to a broad population of investors and differentiate itself from single-style or smaller fund managers. This, together with its strong distribution relationships in Australia and its key growth markets in the U.S., the U.K, and Europe, should help the firm to grow and build a globally diversified client base. In return, Perpetual also benefits from having more growth avenues, and being able to mitigate disruptions from a particular client/distribution channel and also earn various tiers of fee margins.

Perpetual’s enlarged scale will likely give it some headroom to undercut other active asset managers on price, with fees across its products currently below peer averages, on aggregate. The firm’s focus on rolling out new products--such as ESG and retirement-income funds--helps it stay relevant with emerging investor needs. We also believe Perpetual will have comparatively less key person risk and client concentration, which lessen the risk of significant FUM redemptions. It is not reliant on a few large funds or a "star" manager, so it is not materially affected by the departure of a manager.

While the acquisition of Pendal entails execution risks, we believe Perpetual can ultimately avert a material attrition in FUM and prevent material value destruction. Efforts like maintaining investment autonomy, segregating distribution (to minimize cannibalization among its own boutiques) and potentially higher remuneration will likely succeed in retaining staff and preventing large redemptions. Various key managers, including Pendal’s head of equities Crispin Murray, are supportive of the deal, and Perpetual stated client consents are in line with expectations.