Why we're backing this ASX-listed fund manager trading on cheap valuation metrics

Currently investor sentiment is cautious due to high inflation, continued discussion of rising interest rates and the lacklustre performance of equity markets in the last 18 months.

With this backdrop, there are a number of stocks on the ASX that we would class as “good businesses trading on attractive valuation metrics”. One such stock is a funds management business that the Glenmore Australian equities fund is invested in, being GQG Partners (ASX: GQG).

Company overview

By way of overview, 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, both having meaningful “skin in the game”, with Mr Jain owning 69% of the company and Mr Carver owning 6%. Both invested 95% of their IPO proceeds into GQG strategies, with these investments being subject to a 7 year lockup period. Mr Jain was previously the CIO and CEO of Vontobel Asset Management (over a 21 year tenure) where he was the lead portfolio manager across their Global and Emerging Market equity strategies, following a similar strategy to what is being pursued at GQG Partners.

GQG is a large-scale asset manager, with total assets under management at the end of September of ~US$105.8B, spread across four main strategies (all listed equities) – International Equity US$40.3B, Global Equity US$28.4B, Emerging Markets US$28.8B and US Equity $8.3B.

GQG is neither a value nor a growth fund manager but does have a strong focus on “business quality” at reasonable valuations. This strategy has seen Mr Jain (both at Vontobel and GQG) historically outperform during bear markets and still produce solid but not spectacular performance in strongly rising markets. Given the difficult global economic backdrop currently (and for the foreseeable future), to us this seems a sensible strategy.

Importantly, all of GQG’s key equity funds have delivered strong outperformance vs benchmark since inception. Performance in 2022 was assisted by a strategy in late 2021 to reduce exposure to high priced growth stocks (eg. technology stocks) and an increased investment in the energy sector (eg. Oil and gas). Performance over the last 12 months for emerging markets, global and international has been ahead of benchmark, whilst the US fund has lagged vs benchmark slightly (~3%) which we believe was due to an underweight weighting to the large cap tech sector which rallied strongly in the first half of 2023.

In terms of distribution, this is done via three channels: wholesale, sub-advisory and institutional. Institutional is the largest channel representing ~40% of FUM, followed by sub-advisory ~35%. Wholesale, whilst currently the smallest channel, represents a strong source of potential growth.

Management

Rajiv Jain – Chief Investment Officer

• Commenced at GQG in June 2016.
• Previously Co-CEO and Chief Investment Officer (CIO) of Vontobel Asset Management for 21 year (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 global, international, and emerging market equity strategies and oversaw rapid growth of the business with FUM reaching ~US$45B in 2016.

Tim Carver – Chief Executive Officer

• Responsible for firm leadership and management of business functions.
• Prior to joining GQG, Tim co-founded Northern Lights Capital Group (now Pacific Current Group, listed on the ASX).
• Whilst at Northern Lights, Tim oversaw 20 asset management investments and served on several boards of fund management groups.

Key reasons we like GQG

• The business is simple to understand and generates very strong free cash flow, the bulk of which can be returned via dividends (dividend policy is 85-95% of distributable earnings).
• Whilst the Emerging Markets strategy has been soft closed (since 2021), the Global and US equity funds in particular still have material capacity to grow AUM. Management is particularly positive on the prospects for the US equity fund, given its strong long-term performance and low fee structure vs peers.
• GQG’s valuation is attractive, trading on a PE multiple of ~10x.
• Historically the best time to invest in listed fund managers has been during periods of weak sentiment toward the stock market.
• GQG’s funds have relatively low fees and hence do not have material earnings risk from future fee compression, that some more mature fund managers face.
• Also, GQG’s revenues have a very small contribution from performance fees (> 95% of group revenue is from management fees). Hence GQG’s earnings (in theory at least) should be less volatile than fund managers with a greater skew towards performance fees.
• Business quality is solid albeit with key man risk.
• Unlike most of its large fund peers who are facing net outflows, GQG is generating net inflows (though we would concede this could change if sentiment towards equities turned sharply negative).
• Rajiv Jain and Tim Carver are highly competent, very experienced and have material equity ownership in the business.

What could result in Glenmore changing its mind on GQG?

• If the GQG funds were to suffer a period of sustained underperformance.
• Significant changes to key members of the investment team.
• M&A that diluted the current quality of the GQG business or increased the risk profile of the group.
• One potential risk that GQG has is via its sub advisory channel with Goldman Sachs, where the Goldman Sachs GQG Partners International Opportunities Fund makes up a material portion of FUM (we estimate ~60% of the sub advisory channel and ~25% of group FUM). Whilst the performance of this fund has been very strong and hence, we believe the relationship is positive, Goldmans does have the ability to cease the relationship with GQG.

Key man risk

The elephant in the room for potential GQG investors is the key man risk attached to Rajiv Jain.

The recent situation at Magellan Financial Group (ASX: MFG) where the co founder of that business, Hamish Douglass, left the business which then had a material impact on MFG’s FUM, has no doubt impacted the PE multiple that GQG trades on. Clearly if a similar situation occurred at GQQ where Rajiv stopped working at the company, there would also be a material impact on FUM. However, in our view, the most balanced way to look at the key man risk issue is to think about the actual likelihood that Rajiv will actually leave in similar fashion to Hamish Douglass, rather than view the issue as a reason to not invest in GQG at all.

Some relevant points to consider are that Rajiv has been working in funds management for a long time. Prior to co-founding GQG, he had worked at Vontobel Asset Management for 21 years. In that way we see him as a career fund manager, and believe it is most likely he will continue to work at GQG for at least the next 5-10 years. Rajiv is currently 55 years old.

In addition, there are a large number of founder led companies on the ASX that have delivered very strong returns for shareholders. To not invest in these stocks because of key man risk would have seen the investor miss out on material outperformance.

Ultimately, we see the risk of Rajiv leaving GQG due to bad health or lack of motivation to be a low enough probability that means we are comfortable with this risk but that is a decision each investor in GQG needs to make a decision on.

Due to the potential risks around key man departure/s and the performance of its four funds - GQG is not a “buy and put in the bottom drawer” for 3-5 years type of investment. An investor in GQG needs to keep a close eye on the performance of GQG’s equity funds, as any periods of sustained underperformance (ie. multi year) are typically forward indicators of net outflows.

Potential bid for Pacific Current Group (PAC)

A recent interesting development for GQG was its announcement on 27 July 2023 that it intends to submit a non-binding indicative proposal to acquire ASX listed Pacific Current Group (ASX: PAC). This had followed a bid for PAC by ASX listed Regal Partners (ASX: RPL) on 26^th of July.

PAC has a similar business model to the ASX listed Pinnacle Investment Group (ASX: PNI), in that it invests equity in funds management businesses, assists the boutiques with distribution and can offer growth funding if required. PAC has a strong focus on northern hemisphere funds (its CEO Paul Greenwood is US based) and also alternative/unlisted asset managers (ie. Private equity, private credit, real estate).

Somewhat surprisingly, GQG has not since July followed up with a proposal of any sort, whilst RPL pulled out of the process on the 28^th of September, stating it had been consistently disappointed with the level of engagement from the PAC board with regards to its desire to acquire PAC.

It is unclear whether GQG will submit a bid for PAC, and for the time being, it is a case of watch this space. However, we do think the GQG stock price has been negatively impacted to some extent by the uncertainty in recent months so a resolution either way should be positive for GQG shareholders.

Valuation

Despite strong fund outperformance and positive net inflows, GQG continues to trade on cheap valuation metrics.

At a stock price of $1.40, if we assume the company can generate CY23 NPAT of US$260m (in line with broker consensus), the stock trades on a PE multiple of ~10x, and a dividend yield of ~9% (unfranked), which seems too cheap given the quality of the business.

Whilst we concede the days of active, large scale fund managers trading on PE multiples in excess of 20x (noting during 2020 MFG traded on a PE of 25-26x) are almost certainly gone, a PE multiple of 14-15x seems fair in our view.

One risk (apart from the key man issue) for the stock price is continued high levels of inflation, meaning central banks have to raise rates higher and for longer than is anticipated by investors. This in turn would mean a continued period of weak investor sentiment towards listed fund managers.

Whilst we concede this is a risk, for an investor in GQG willing to take a 3 year view, we don’t see this as a deal breaker as our base view at Glenmore is that central banks will bring inflation back to more acceptable levels in the next 12-24 months, given how aggressively they raised rates in the last 18 months. In the meantime, GQG investors will receive a very healthy dividend yield.

With group FUM now at US$105B, it should be acknowledged that investors have already missed a period of huge valuation uplift, which occurred from 2016 (when GQG was founded) to now. However, we still believe there is clear scope for the company to grow FUM and earnings over the next 3-5 years.

Overall, we see the stock as cheap and believe a valuation of $2.00 - $2.20 is quite achievable over a 1-2 year timeframe, albeit this would require an improvement in investor sentiment towards equities.