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Morningstar | Magellan Expertly Navigating Wild Seas With Another Strong Half. AUD 29 FVE Unchanged

Narrow-moat Magellan Financial Group announced an impressive set of half-year results, delivered against a backdrop of turbulent markets. Underlying net profit after tax, or NPAT, increased by 62% from the previous corresponding period, or pcp, to AUD 176.3 million driven by increased funds under management, or FUM. Within the six months, spot FUM increased to a high of nearly AUD 75 billion before dipping to AUD 70.8 billion by the end of December as higher volatility gripped global markets. Even so, we were encouraged that inflows from clients remained strong even in the face of stormy seas. Adverse market conditions saw market returns fully offset by cash distributions, but this was more than offset by inflows totaling AUD 1.4 billion in the half year, all of which demonstrates Magellan appeal to investors by virtue of its strong brand and track record of outperformance. Average FUM grew to AUD 72.1 billion, up from AUD 53.6 billion in the pcp. Both underlying EPS and interim dividends grew above market expectations, increasing from the pcp to AUD 99.8 cents and AUD 73.8 cents per share, respectively. The global asset manager continues to perform in line with our expectations. We have adjusted some of our earnings forecasts, but retain our fair value estimate of AUD 29. At current prices, the stock screens as fairly valued.

Magellan continues to grow its share of money managed for institutional clients. This increased to AUD 51.8 billion in December from AUD 50.3 billion in June, accounting for close to three fourths of its total FUM pool. The asset manager’s institutional client base grew marginally in its concentration, but we still view the overall client pool to be well diversified given the top 30 institutional clients contribute less than 40% of total management and services fee revenue. The remaining FUM are managed for retail clients, which fell marginally to AUD 19.0 billion in December from AUD 19.2 billion in June.

Central to Magellan’s favourable results were positive fund inflows from both its institutional and retail client base even in the face of difficult market conditions. Encouragingly, inflows from institutional investors totaled AUD 886 million, whereas retail clients contributed an additional AUD 475 million. Both were down from the pcp, however, we note this was delivered amid a period of lacklustre market returns globally. We were encouraged many of the group’s offerings have garnered momentum, particularly the more recent products targeted to retail investors. These include the Magellan Global Trust (MGG) as well as its three open-ended Active-ETFs (MGE, MHG, and MICH) which have collectively grown their fund sizes to a total of AUD 3.1 billion. Meanwhile, Airlie Australian Share grew from around AUD 7.2 million to AUD 12.6 million. In addition, Magellan’s global listed Infrastructure strategies continue to attract strong interest. On the flip side, management’s tone regarding the uptake of its institutional Sustainable strategies was more moderate, and there is also a new suite of retirement and income products in the works. In our view, it could take anywhere between three and five years for the asset manager’s new strategies to build a credible track record in order to stimulate any meaningful FUM inflows. To this end, our forecasts of FUM growth assumed only incremental rates of FUM inflow in line with management’s guidance. Moving forward, we expect total FUM to increase by an average of 8.8% per year towards AUD 106 billion by fiscal 2023.

Even as volatility spooked global markets, Magellan’s flagship strategies delivered upper-quartile investment returns well ahead of their benchmarks both in the half year, and over the longer term. The Magellan Global Fund returned 9.8%, 9.2%, and 11.4% on a trailing 1-year, 3-year and 5-year basis--beating its 9% performance objective as well as the MSCI World NTR Index. Similarly, the Magellan Infrastructure Fund delivered returns in excess of its benchmark both over the short and long term. No surprises here as performance fees totaled AUD 42.7 million, up threefold from the pcp. In forecasting Magellan’s expected future returns, we have applied Morningstar’s internally developed midcycle market return expectations (by region) to each of Magellan’s funds. Specifically, we have assumed a market return of around 8% per year over the forecast period. While our newly assumed market returns are noticeably more conservative relative to Magellan’s historical performance, equity markets tend to mean revert over the longer term and as such we have applied a "through-the-cycle" return assumption.

As always, Magellan’s higher FUM balance helped pave the way for higher management fees during the half year, with base management fees up by 28% from the pcp to AUD 225.8 million. Average base management fee margins were slightly down by 2 basis points to 63 basis points, but this was due to a mix shift towards institutional FUM over the half year. We think there is no reason for Magellan to lose hold of its current fee margins anytime soon. Institutional investors are generally less fee-conscious, so we see no immediate threat of a fee compression so as long as its flagship products can continue to deliver excess returns compared with their benchmarks. On the other hand, retail clients are stickier in nature and highly regard the Magellan brand, which the asset manager fortified through building an impressive track record spanning beyond a decade.

Operating expenses were down by 4% on the pcp, largely due to a reduction of marketing expenses resulting from the cessation of marketing expenses to Frontier (following its acquisition by Magellan) as well as the group’s withdrawal from the partnership with Cricket Australia. In a structurally challenged, more competitive investment climate, we think asset managers like Magellan will increasingly spend on talent management to maintain investment outperformance and business development initiatives to enhance distribution and brand presence. Accordingly, we believe it is more likely for the trajectory of cost metrics (such as cost/income or cost/average FUM) to be upwards for active managers, with our future projections of operating costs (including staff and marketing) reflective of this. Nevertheless, Magellan’s operational efficiencies remain superior to many of its listed peers, thanks to rapid rates of FUM accumulation in recent years.