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Morningstar | Platinum’s Better FUM Growth So Far in 2019 Not Enough to Offset Prior Underperformance, FVE Cut

A transition to a new analyst results in a reduction in narrow-moat Platinum’s fair value estimate to AUD 4.90 per share from AUD 5.50. Although Platinum’s core funds have performed better in the four months to April 30, 2019, we expect the underperformance in the nine months to Dec. 31, 2018 will significantly reduce performance fees in fiscal 2019. That said, the lower fees should be partly offset by a reduction in variable employee expenses. When compared with fiscal 2018, this results in a forecast 12% reduction in fiscal 2019 net profit after tax, or NPAT, to AUD 168.5 million.

We also took the opportunity to compare Platinum with Australian global equity manager peer Magellan Financial Group to determine the reasons behind Magellan’s significant outperformance relative to Platinum over the last five years. Our analysis suggests Magellan has built a stronger foundation for likely higher, less-volatile earnings growth than Platinum, which we believe justifies Platinum’s lower fiscal 2019 P/E of 17.1 times compared with Magellan’s of 18.7 times at their respective fair value estimates.

The recent inconsistent performance of Platinum’s funds along with its contrarian investment style and current exposure to developing market stocks is likely to lead to more subdued funds under management, or FUM, growth in the near term in the face of global growth concerns. We think consistent fund performance for a period of at least three to five years and a resolution of U.S. trade tensions with China as well as an improvement in global growth prospects is required to attract meaningful fund inflows from clients. While fund performance has improved in the first four months of 2019, generally Platinum’s core international and Asian funds have underperformed their benchmarks over the last five years.

We forecast a 6% increase in average FUM in fiscal 2019, driven by much stronger performance in the four months to April 30, 2019. There is significant divergence in the drivers of FUM growth in the six months to Dec. 31, 2018 and the four months since. The first six months of fiscal 2019 to Dec. 31, 2018 saw ongoing poor fund performance which began earlier from March 31, 2018. We expect the poor fund performance was due to a combination of the escalating threat of a trade war between the U.S. and China, the threat of the U.S. Federal Reserve increasing interest rates (which now appears less likely), tightening of credit in China, and global growth concerns. This was a reversal of the better performance in the first nine months of fiscal 2018 and fiscal 2017.

The strong performance in the prior periods likely attracted client inflows which helped offset part of the poor fund performance in the first six months of fiscal 2019. We believe the reverse has occurred in the first four months to April 30, 2019. Fund performance improved significantly in the first four months on a rebound in global equity markets, more than offsetting client outflows of AUD 543 million. Client outflows are likely a lagged response to the poor fund performance of the prior nine months and inconsistent performance over the past five years.

We forecast Platinum’s average FUM to grow by a CAGR of 4.9% in the next five years from fiscal 2018, which compares with the 4.6% growth in the last four years and 9.5% growth in the last five years. FUM growth should primarily be driven by global equity markets in the near term, so we expect some volatility in FUM growth. FUM growth is a key driver of earnings and we think the much slower growth in average FUM is the main contributor to the underperformance of Platinum when compared with peer Magellan Financial Group. Magellan’s average FUM has grown by a CAGR of 44.6% over the last five years, multiple times better than Platinum.

Several factors contribute to Magellan’s relatively stronger FUM growth. While a small part is due to the Airlie acquisition, relative to Platinum, we think the main contributors are Magellan’s retention of key portfolio managers and analysts, stronger fund performance and higher fund exposure to more developed-markets stocks. Investors typically want to see stability in the personnel managing funds prior to investing. Magellan has retained its key portfolio managers including cofounder Hamish Douglass, whereas Platinum has lost several key analysts and portfolio managers who established a competing firm Antipodes Global. Platinum cofounder Kerr Neilson also recently relinquished portfolio management responsibilities of Platinum’s flagship funds, although he remains an employee and majority shareholder. We think Platinum’s personnel changes have made it harder to retain and attract funds.

Investors also typically require an extended period of strong fund performance prior to investing in a fund. They’ll consider the composition funds, focusing on how individual stocks, as well as sector and geographic exposures are likely to perform in the context of the broader macroeconomic backdrop. Compared with Platinum, Magellan has more of an exposure to information technology, Internet and e-commerce and consumer defensive companies with a significant exposure to the U.S. On the other hand, Platinum’s core International Fund has a relatively higher exposure to financials, communication services, industrials and materials with a higher exposure to Asian markets like Japan, India, and China and less relative exposure to the U.S. than Magellan. The composition differences of their core portfolios have led to the outperformance by Magellan’s core global funds relative to Platinum’s core global strategies over the last five years. Unlike Platinum’s core funds, Magellan’s core global funds have also outperformed their benchmark over one-, three-, and five-year periods. The steady outperformance directly contributes to FUM growth, but also indirectly contributes to growth by assisting in retaining clients and attracting more net inflows from clients.

We also think the different composition of Platinum and Magellan’s client bases has also contributed to the differences in FUM growth. Retail clients are typically more influenced by short-term performance relative to institutional clients, who generally take a longer-term view. Consequently, we expect Platinum’s higher composition of retail clients in combination with its inconsistent performance contributed to Platinum’s lower FUM growth. Platinum sources most of its FUM from retail clients, with the typical split of between 75%-80% retail, and 25%-20% institutional. This is the opposite of Magellan. Despite recently implementing a strategy to increase penetration in the retail high net worth market, Magellan currently manages about 27% retail and 73% institutional funds.

Compared with Platinum, we also believe Magellan is better positioned to generate future higher earnings growth. Although Platinum’s much higher composition of retail FUM means it is generating higher margins on its FUM than Magellan, the palpably higher FUM growth rates achieved by Magellan have allowed Magellan to generate materially higher earnings than Platinum. In fiscal 2018, Platinum’s management and administration fees on average FUM of 1.16% was much higher than Magellan’s circa 0.65%. Notwithstanding, Magellan’s materially higher growth in FUM more than compensates for the lower margins. Over the last five years to fiscal 2018, Platinum generated CAGR in underlying NPAT attributable to shareholders of about 8% whereas Magellan materially outperformed generating a CAGR of circa 32%.

We also think the higher FUM growth rates now provide Magellan with much greater opportunity to benefit from scale advantages, with Magellan’s total FUM standing at about AUD 83.2 billion as at April 30, 2019, materially exceeding Platinum’s total FUM of about AUD 26.6 billion. The management fees on the higher FUM balances effectively acts like a royalty in the absence of net outflows. Furthermore, while Platinum and Magellan are both highly sensitive to global equity markets, the composition of Platinum’s funds with their current skew to less defensive developing countries and stocks, combined with their recent underperformance and greater reliance on retail clients we believe makes Platinum’s FUM and in turn earnings more sensitive than Magellan’s to unpredictable macroeconomic issues like the U.S. trade war with China, concerns regarding Chinese growth and actions by the Fed. We expect these factors will result in Platinum generating more volatile and slower FUM and earnings growth which justify Platinum trading at a lower multiple than Magellan.