Is there value on offer amongst the ASX fund managers?

Given the recent bidding activity in the listed funds management sector on the ASX, we thought it would be timely to examine some of the key players in the space, as well as discussing their respective strengths and weaknesses, earnings prospects and valuations.

Of particular interest is the recent bidding for one of our fund’s holdings, Pacific Current Group (ASX: PAC) from Regal Partners (ASX: RPL) and to a lesser extent GQG Partners (ASX: GQG), who announced an “intention to submit a non-binding, indicative” proposal on the 27 July, though to date a formal bid has not yet been announced.

Pinnacle Investment Management (ASX: PNI)

Stock price $9.77, market cap $1,965m

PNI’s business model is based on investing equity in boutique fund managers, providing growth capital and distribution expertise, in return for a share of profits from the fund manager. The logic is that PNI does all the work that is not related to the investment function which allows the investment team to focus on researching stocks and managing funds. In total, PNI has a portfolio of 15 affiliate funds. Some of PNI’s better known affiliates include Hyperion Asset Management, Antipodes, Coolabah Capital Investments and Firetrail Investments. As many readers would be aware, PNI has been a very strong performer on the ASX over the last 5-7 years, having achieved group FUM growth of 23.8% pa (CAGR) over the last 10 years. EPS growth for the five years to FY23 was an equally impressive 24.2% pa. PNI’s stock market rating benefits from not having the key man risk issues that companies such as Magellan Financial Group (MFG) and GQG Partners (GQG) have, as well as having an earnings base that is diversified across multiple asset classes (domestic and international equities, fixed interest, private equity), although we do note ~80% of group FUM is linked to publicly traded markets.

PNI’s recent FY23 result was impacted by weaker than normal inflows, particularly on the retail side (retail FUM is ~25% of group FUM). Despite this, group FUM (100% basis) increased 10% to $92B at 30 June 2023.

With PNI currently trading on a forecast FY24 PE multiple of ~23x and group FUM of ~$92B, it will be interesting to see if it can continue to deliver such strong EPS growth and stock price performance over the next 3-5 years. One area to watch is PNI’s expansion into offshore markets, where it is well funded if opportunities arise. We believe PNI will continue to increase its exposure to non traditional strategies such as private capital, absolute returns and credit. At this point in time, we view PNI as a high quality business, albeit fairly valued.

Pacific Current Group (ASX: PAC)

Stock price $10.40, market cap $536m

PAC has a similar business model to PNI, in that it invests equity in funds management businesses, assists the boutiques with distribution and can offer growth funding if required. Where PAC differs from PNI is that it has a greater focus on northern hemisphere funds (note CEO Paul Greenwood is US based) and also alternative/unlisted asset managers (ie. Private equity, private credit, real estate). PAC currently has a portfolio of 16 boutiques in Australia, India, Luxembourg, the US, and the UK. PAC receives its share of earnings from its boutiques and targets a dividend payout ratio of 60-80%.

Most of PAC’s affiliates would not be well known to Australian investors, however we believe PAC has put together a portfolio of funds that have solid performance, excellent scope for further AUM growth and performance fees, and importantly are not overly reliant on favourable external equity market conditions.

Examples include Pennybacker Capital (PAC stake - 16.5%), a US based fund manager specialising in private real estate, which has a very strong performance track record and is well placed for future AUM growth. Another is US based Victory Park (PAC stake - 24.9%), which operates in private credit and has excellent near term growth prospects.

One affiliate of PAC’s that is well known to ASX investors and does have strong reliance to equity markets is its holding in GQG Partners (GQG), however the vast majority of PAC’s funds are not linked to public markets. PAC owns 4% of GQG, which currently is worth ~$190m.

PAC has not had anywhere near the stock price success that PNI has had over the last 5-7 years. Historically, PAC has traded on a much cheaper valuation metrics than PNI, which in our view, is due to lower EPS growth (underlying EPS grew from 38.4 cents per share in FY18 to 53.2 cps in FY22).

Bidding activity for PAC

On 26 July, Regal Partners (RPL) announced a proposal to acquire PAC for $10.77 per share, a 30% premium to PAC’s 30-day average price of $7.19. The offer comprised of $7.50 per share in cash, plus 2.2 shares in GQG Partners (GQG) valued at $3.27 per PAC share.

RPL has entered into a co-operation agreement with PAC’s major shareholder River Capital regarding pursuing funding support. RPL’s existing stake in PAC is 11.7%, whilst River’s is 19.1%.

The bid from RPL was interesting in that M&A activity in the boutique fund manager sector has been quite rare, which we put down to the nature of funds management businesses which tend to be businesses focussed on key people rather than products or standardised systems.

Even after the recent spike in the stock price following Regal’s bid, PAC’s valuation remains undemanding. At a stock price of $10.40, PAC is trading on a forecast FY24 PE multiple of ~14x and dividend yield of ~5%.

The day after RPL announced its bid, GQG announced an intention to submit a non-binding indicative proposal to acquire PAC. GQG has a long history with PAC and hence would have strong knowledge of the business and many of its boutiques. To date, GQG has not followed up with a formal bid, so for now it is a case of watch this space.

GQG Partners (ASX: GQG)

Stock price $1.62, market cap $4,798m

GQG is a global funds management business based in Fort Lauderdale in the USA. The company was founded in 2016 by Rajiv Jain and Tim Carver. Rajiv Jain is the CIO of GQG and owns a ~69% stake in the business. There is undoubtedly material key man risk at GQG with Rajiv Jain, hence it is worth discussing his background prior to his time at GQG. Rajiv commenced at GQG in June 2016. Previously he was co-CEO and Chief Investment Officer (CIO) of Vontobel Asset Management for 21 years. By way of background, Vontobel Asset Management is a large financial group (investment banking and funds management) headquartered in Zurich, Switzerland. In his time at Vontobel, Rajiv was responsible for both emerging and developed market equity strategies and oversaw the growth of the business from US$400m to just under US$50B of FUM in 2016.

GQG listed on the ASX in October 2021 at a stock price of $2.00. FUM at the time of IPO was US$86B, which has since grown to ~US$108B.

Current FUM break up is as follows:

• International Equity US$41B
• Global Equity US$29B
• Emerging Markets Equity US$29B
• US Equity US$9B

GQG’s dividend policy is to pay out 85-95% of distributable earnings, hence dividends are an important component of returns to investors.

The vast majority of the company’s funds are involved in the northern hemisphere and publicly listed markets.

Despite excellent fund performance and strong net inflows since IPO, GQG continues to trade on cheap valuation metrics. If we assume the company can generate CY22 NPAT of US$260m, the stock trades on a PE multiple of ~12x, which seems too cheap given the quality of the business. Also, investors will receive an attractive dividend yield of ~8%. Whilst we believe the days of active, large scale fund managers trading on PE multiples in excess of 20x are almost certainly gone, a PE multiple of 15-16x seems realistic.

We believe a stock price of $2.00 - $2.20 is quite achievable over a 12-18 month timeframe, particularly if central banks globally ease from the current interest rate hiking phase, which is impacting investor sentiment towards listed fund managers.

Following RPL’s bid for PAC, GQG quickly announced an intention to lodge a non-binding, indicative bid to acquire PAC. The move was surprising to us, given our impression that M&A, particularly in the unlisted asset manager space, was not a priority for GQG. At the time of writing, GQG has not followed up with a bid.

Regal Partners (ASX: RPL)

Stock price $2.33, market cap $593m

RPL is an ASX-listed, specialist alternative investment manager with ~$5.8B in funds under management. RPL, the listed entity came about following a merger in 2022 between the unlisted Regal Funds Management and (ASX listed) VGI Partners. RPL has a range of investment strategies covering long short equities, private markets, real and natural assets and capital solutions with an investor base including institutions, family offices, charitable groups and private investors.

RPL currently houses four dedicated alternative investment management businesses – Regal Funds, VGI Partners, Kilter Rural and Attunga Capital. Long short strategies currently account for ~2/3 of RPL’s FUM.

The free float of RPL is quite limited, due to key shareholders Phil King (35%) and VGI co-founder Rob Luciano (17%) owning materials stakes in the business. However, we believe RPL is very keen to improve the liquidity of the stock over time. There is significant key man risk around Phil King in particular, though we would note RPL’s earnings are well diversified across numerous strategies.

In terms of fee structure across its funds, RPL fees are above average due to the specialised nature of its funds, with particularly significant earnings potential from performance fees. This could result in a more volatile earnings stream from RPL than peers that have less exposure to performance fees. This is in contrast to GQG, where its long only funds earn the vast majority of revenue (~95%) from management fees. In addition, GQG’s management fees are low versus its peer group, being placed in the bottom quartile.

Regarding its bid for PAC, RPL said it sees scope for revenue synergies through adding PAC’s boutiques to its existing distribution channel, as well as utilising PAC’s distribution (particularly offshore) to help sell its own products.

At this stage, we think the combination of RPL and River Capital are most likely to gain control of PAC. In our view, for GQG to be successful in bidding for PAC, they would need a bid that is well in excess of where PAC is currently trading (~$10.50 per share).

Magellan Financial Group (ASX: MFG)

Stock price $9.57, market cap $1,738m

MFG has had a well publicised period of operational volatility in recent years. The company was a standout performer on the ASX from 2011 to 2020, driven by solid fund performance and strong fund marketing, which saw consistent net inflows into its global equities and infrastructure products. After FUM peaking at $116B in November 2021, it now sits at $39B (Global equities $18B, Infrastructure $16B, Australian equities $5B).

To recap, the main driver of the decline of the company’s fortunes can be linked to when co-founder and key company figure head Hamish Douglass stepped down from his role as Chief Investment Officer (CIO) in February 2022 and then as board member in March 2022. In addition, performance of the flagship Magellan Global Fund has been subpar in recent years.

Since, Hamish Douglass has left MFG, the business has seen consistent outflows, which makes the company difficult to value and form a view as to what earnings can be generated over the next 3-5 years.

Given the material key man risk that centred on Hamish Douglass and level of outflows in the global equities product, it is difficult to have a strong conviction on MFG as an investment currently and we would prefer to focus on other fund managers on the ASX with more stable investment management teams.

CONCLUSION

Overall, we believe the funds management sector on the ASX should continue to be an area of interest to investors.

Whilst there is often key man risk and barriers to entry are not particularly high, the businesses do generate very strong levels of free cashflow, have strong operating leverage (at times of strong inflows), and can launch new products quite easily with little capex requirements.

Assuming inflation continues to gradually reduce over the next 12-18 months, we believe investor sentiment towards the sector should improve further once the pace of interest rate hikes from central banks globally begins to moderate.