Is the disaster over for this former market darling?

It seems the bad times keep rolling for this former market darling, today revealing that funds under management nearly halved over the past financial year to $61.3 billion. 

It's probably no surprise then that Magellan Financial Group's (ASX:MFG) management team are the first to admit it has been a "difficult year", filled with "significant challenges" and "material client outflows" that have seen its share price plunge more than 65% over the past year.

Retail outflows haven't been the only thing headed south. Recall the loss of the $23 billion St James Place mandate in December last year. Now, Magellan reveals that institutional funds have fallen 53% from $83 billion to $39 billion. 

Dividends have also taken a hit. They've fallen 37% from the 110.1 cents per share (cps) interim dividend announced in February to just 68.9 cps. On the plus side, for those hanging on to their Magellan shares, the total dividend for the year was 179 cps, up 30%. 

Then, of course, there was the ultimate departure of co-founder and chairman Hamish Douglass, the exit of chief executive Brett Cairns, and most recently, the announcement that Magellan's long-standing head of sales and distribution, Frank Casarotti, would retire in December 2023. 

So do these departures, defunct deals and draining funds spell further disaster for this former market darling? Or can Magellan leave this objectively horrible year behind it? In this wire, Montgomery Investment Management's Roger Montgomery details why he believes they can turn it all around. 

Magellan Financial Group's FY22 key results

• Average funds under management (FUM) down 9% to $94.3 billion. Total FUM on June 30 was $61.3 billion, down 46% from total FUM at 30 June 2021. 
• Statutory net profit after tax (NPAT) up 44% to $383 million. Adjusted NPAT down 3% to $339.7 million. 
• Adjusted diluted earnings down 4% to 215.9 cents per share. 
• Final dividend of 68.9 cents per share, down 37% from the first half. Total dividends for FY22 were 179 cents per share. 
• Balance sheet: No debt, $915.5 million in net tangible assets, $963.3 in cash, financial assets and investments in associates. 

Note: This interview took place on Wednesday 17th August 2022. Montgomery Investment Management doesn't currently own Magellan in any of its funds. You can learn more about Montgomery's investment strategy and funds by clicking here. Magellan was formerly an investor in Montgomery Investment Management, but Roger and the team bought back that stake in 2018. 

What were the key takeaways from this result? What surprised you the most?

I'll start with the big news first. The surprising part was that they had noted in the first half that exit fee margins were 65 basis points (bps) at December 31. And now the average margin is coming in at about 62-63 bps. But in December, they had also said that there was a mix shift towards retail, which in theory, should have meant a higher margin. 

So we can presume one of two things, or maybe both. The first one is there's institutional fee pressure. So if they are actually mix shifting towards retail, and it is at a higher margin (which it should be), then it means that there's even more pressure than what some analysts might have anticipated on the institutional side. And that would be consistent with the notion that they have lost more institutional mandates. 

FUM, of course, is down 9% on the prior corresponding period to $94.3 billion. But that was pre-announced. The other thing that's possible is that the distribution team are discounting fees to keep people on board, even in the retail space, so whether they're dealing with platforms and/or dealer groups, they may be negotiating lower fees in retail in order to retain FUM. 

That's consistent with what I think is the most important indicator when investing in funds management businesses, and that's the three-year Alpha numbers - so their three-year performance number. Now, on their flagship Fund, which is the Global Fund, they've underperformed the benchmark by about -6.3% per annum over three years. 

You won't start seeing FUM stabilise and rise until you see that three-year number start to improve. So that's what investors should be watching. 

The second takeaway is there was no guidance given and there was no presentation available... yet. Now, there may be a presentation later in the day, but it's possible that the new CEO David George might be working on a new strategy and may want to tie in his first presentation to some strategic changes that he might be making at the firm. And that wouldn't be surprising to me. They're the two main takeaways from the result.

What was the market’s reaction to this result? Was this an overreaction, an underreaction or appropriate?

I think the sell-off we are seeing today is reasonable given the market is very, very nervous about any company that misses guidance. But of course, a good funds management business is an extremely profitable one. So that may limit any further damage to the share price after the initial reaction.

In the absence of very, very dramatic losses in FUM, I reckon the shares are trying to form a bottom. I don't know anything about technical analysis and I'm not going to pretend to, but it does look like it's sort of stabilising around here - down about 80% from its highs. 

As I said, if three-year performance can start to improve on their flagship product, if they could start to get that three-year number up or less negative - and that only takes a really good quarter or two to transform that number - then you may see FUM stabilise and in fact, even start to grow.

Would you buy, hold or sell Magellan on the back of these results?

Rating: HOLD

It would be a hold. I'd like to buy it because I think the people are tremendous in that company, but I really want to see that three-year performance number start to improve. We don't currently own it across any of our funds, but that could change. 

What’s your outlook on Magellan and its sector over FY23?

I think Hamish Douglass and Chris Mackay have built a phenomenal brand. I think they've lost fantastic talent in Frank Casarotti, who is retiring at the end of next year - so they'll lose a great talent in their distribution team. But I believe the strength of their brand and the quality of the people in the organisation means long term, provided those three-year numbers can improve, they've got an awesome business.

I think the funds management industry is under pressure on the fee front, but quality managers who can outperform deserve the fees they earn. We are already seeing consolidation within the sector, which is a natural part of trying to gain efficiencies of scale when fees are under pressure.

So you're seeing that with Pendal and Perpetual, for example. And I think there's more to come. 

Are there any risks to Magellan and its sector that investors should be aware of given the current market environment?

Just watch the three-year number, that guides everything else. The share price is down 80% from its highs, so I think it is already taking in a very negative scenario. And if they can turn that three-year number around, it's probably very, very good value here. 

I don't think the departures and outflows spell more disaster for Magellan, not at all. They can turn the ship around easily. All they need to do is improve those three-year numbers. 

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious about the market in general?

Rating: 3

In June, I wrote that it was very cheap. That was in June, it's now rallied. So I'd put it at a three, meaning, the market is looking slightly expensive. 

I am less excited than I was in June when I thought the market looked like good value. Now I think the rally might have gotten ahead of itself. 

There's an expectation that inflation has now peaked, and that's probably correct, but it's a long bow to draw to now say that inflation is heading interminably to the 2% target that the Fed has. I think inflation could be sticky at higher levels, even though I think it's also pegged, so that might disappoint equity investors who are expecting rate cuts next year. We probably won't get those rate cuts next year.