Ask the analyst: Did the rise of passive doom Platinum and Perpetual?
A reader asked what is behind the poor performance of Platinum and Perpetual shares in recent years. Shaun Ler stepped in to answer.
Ask the analyst is your chance to ask questions about the ASX companies and industries under our coverage. Please email your questions to [email protected] and I will put them to the analyst responsible. It may appear in a future edition of this series.
Today’s question
Today’s question came from Irene, a self-directed investor who holds Perpetual and Platinum in her portfolio.
Irene wanted to know if there is any light at the of the tunnel for active asset managers after a tough few years. She also wanted to know if this weakness is down to the rise of passive investing.
I put these questions – and a couple of my own – to our financials analyst Shaun Ler. The rest of this article is a summary of a few things Shaun touched on in our conversation. First, though, a bit of context.
Here are the five year share price returns for an ASX200 index ETF, Perpetual and Platinum over the last five years:
- +25% for the ASX200 index
- -74% for Platinum (ASX: PTM)
- -45% or thereabouts for Perpetual (ASX: PPT)
Oh dear. Shaun started by explaining why Platinum’s shares have done so poorly. As it turns out, it is all about a word beginning with the letter 'p'. But that word isn’t passive. It is performance. Shaun says that Platinum’s main funds simply haven’t posted good enough returns to hold onto investors and attract new ones.
Platinum is focused purely on global equities management and global stock indices – far moreso than the ASX – have done really, really well for most of the past five years. Not only that, those returns have often been driven by just a few benchmark heavyweights.
When the biggest weights in a benchmark are 1) the biggest weights by a considerable distance and 2) perform incredibly well, this makes it difficult for active managers to add value. Take the Platinum International Fund, which has a Bronze medalist rating from Morningstar, for example.
This fund’s record since inception in 1995 is actually very good. It has returned over 11% per year, which is not to be sniffed at. Over the past five and ten years, though, it has lagged the benchmark by some distance.
Against a backdrop like this, it isn’t hard to understand why some investors might think about taking their money elsewhere or putting it an index fund and paying annual management fees closer to 0.1% than 1.35%.
Platinum’s FUM has fallen from $23.5 billion on June 30, 2019 to $13 billion on June 30 this year. This is because outflows have far outstripped the compounding of funds that remained in Platinum’s products.
Figure 2: Platinum FUM as of June 30 each year. Source: Annual report data, created with Datawrapper.
The problem isn’t just performance and outflows though, says Shaun Ler.
It has also been that Platinum’s cost structure is bloated. Especially its generous remuneration structure for managers that have generally underperformed. Taken together, profits have taken a beating and so have the shares.
The pain might be over soon for Platinum shareholders, though, as it subject to a takeover effort by Regal. Let’s move on to the case of Perpetual.
Why have Perpetual shares fallen?
When it comes to pinpointing why Perpetual has fallen, there are a few more moving parts. A difficult environment for active managers has definitely played a role. But so too have capital allocation decisions that, in Shaun’s opinion, may have destroyed shareholder value.
Shaun isn’t against the consolidation of active asset managers – in fact, he thinks it continues to remain quite likely. But as Warren Buffett famously christened the golden rule of capital allocation, “what is smart at one price is stupid at another”.
Shaun thinks it is now pretty clear that Perpetual overpaid for its biggest purchase, Pendal. And he isn’t 100% on board with the strategy behind that acquisition, either.
A lot of Pendal’s funds and products are very similar to ones that Perpetual was offering already. By contrast, its more synergistic (but a lot smaller) acquisitions of Barrow Hanley and Trillium helped diversify its product offering and exposure to the performance of different asset classes.
Break-up looks likely to go ahead
Just like Platinum, Perpetual’s share price woes attracted the attention of M&A vultures. And in May, it announced that private equity shop KKR will buy its Corporate Trust and Wealth Management businesses, leaving Perpetual as a pure-play asset manager.
Shaun says that the headline consideration for these assets – some $2.2 billion – sounds like a good price on paper. But the ultimate proceeds will depend on how several costs related to the transaction shake out, such as tax, transaction and separation costs, and net debt adjustments. Management recently guided to a range of $368m to $532m for these costs.
What will Perpetual do with the remaining cash?
Shaun says it is unlikely that shareholders would be happy with anything other than capital returns in some form (a dividend or share buyback). After the Pendal purchase, he says, shareholders would be unlikely to stomach another acquisition in the foreseeable future.
What’s the endgame for Perpetual?
I then asked Shaun how likely it is that Perpetual’s remaining asset management business gets taken over, too. He says that while it isn’t impossible, it doesn’t seem that likely.
For one, it is a far more complex takeover target than companies like Platinum, for example, which is focused on one asset class (international equities) and has fewer funds. The larger and more nuanced nature of Perpetual’s business would make it much harder and more expensive for a buyer to integrate.
Assuming the KKR deal goes ahead, Shaun thinks it is more likely that Perpetual will plug along as an asset management pureplay.
He thinks that management will likely “play defense” for the foreseeable future and focus mainly on cost cutting, for example by merging similar funds between Perpetual and Pendal, while hoping for a turnaround in fund performance.
Are Perpetual shares cheap?
Shaun’s $24 Fair Value estimate for Perpetual shares bakes in an estimate of further outflows. However he thinks that this will be more than offset by asset values in its various products growing. Overall, he thinks Perpetual can grow its FUM by an average of 4.5% per year over the period to 2029.
Unfortunately for the company’s bottom line, however, he thinks that competitive pressures in the industry (including from passive funds) will continue to pressure fees and Perpetual’s profit margins. Shaun’s valuation suggests that the shares were undervalued at a recent level of around $20.85.
Still a place for active, but change might be needed
As we noted earlier, it has been a tough period for active managers worldwide. Shaun doesn’t think that demand for their services will ever disappear, but he was insistent that innovation is needed. This is especially true in relation to fees, which have been shown up by increasingly low-cost passive funds.
Ler doesn’t think that flat fees of 1%+ (taken no matter if the fund performs poorly) will work anymore. Instead, he thinks that funds will need to get closer to passive management fees while finding ways to layer in performance fees in a way that investors don’t find repulsive.
To adjust to such a change, Ler thinks there would also need to be a reset in the way that many active managers compensate their teams. High manager salaries should only really be earned after outperformance has been delivered – not regardless of results.
Have your say – or ask a question of your own
What do you think the future holds for active asset managers?
Given the key role of performance in attracting inflows and how few managers manage to beat market averages, is active management just a rather hard business to succeed in over the long term?
Write and let me know at [email protected]. Or if you have a question of your own about any ASX company or industry in our coverage, please send it to the same email for consideration.
Remember that any individual share or investment should only be considered as part of a broader investing strategy. For a four-step guide to establishing a strategy, read this article by my colleague Mark LaMonica.
