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Morningstar | PTM Updated Forecasts and Estimates from 04 Mar 2019

Narrow-moat Platinum Asset Management’s first-half fiscal 2019 results were, while underwhelming, in line with recent guidance. Underlying NPAT was down 38% on the previous corresponding period, or pcp, to AUD 65.2 million as closing funds under management, or FUM, fell to AUD 24.1 billion in December from AUD 25.7 billion in June. Positive net inflows of around AUD 700 million weren’t enough to plug the AUD 2.2 billion hole created by investment underperformance over the half year. Nevertheless, our AUD 5.50 fair value estimate for the asset manager remains, underpinned by the Asia region growth story, a difficult to replicate value-based strategy and a strong brand. At current prices, the stock screens as undervalued.

A key highlight over the first half was renewed momentum in net inflows. In contrast to its major competitor Magellan Financial Group, the majority of Platinum’s FUM are managed for retail clients, who collectively account for around 75% of Platinum’s total FUM. Not surprisingly, net inflows were skewed towards the earlier part of the half where Platinum was still benefiting from strong performance the year before. Net flows totaled AUD 689 million but 88% of these came in the first three months of the half while, concerningly, December was the first month of the half to display net outflows. Momentum was strong in Platinum’s retail flagship products with both the Platinum International Fund and Platinum Asia Fund contributing AUD 503 million and the ASX-quoted funds collectively amassing more than AUD 160 million. Given the decline in recent investment performance, we expect little to no net inflows over the second half.

Despite outperformance over the longer term, Platinum’s significant underperformance across most portfolios in the most recent 12 months will present challenges to flows and profitability near term. Lacklustre investment performance saw negligible performance fee revenue over the half compared with AUD 20.8 million in the pcp. The asset manager’s core International strategy has a large regional exposure towards Asia, and as persistent concerns about the trade war affected Asian stocks, it came with no surprise that Platinum International continued to underperform the U.S.-centric MSCI AC World Net Index. We also witnessed material underperformance in the Asia Fund, which trailed its benchmark by 5.3% in the 12 months to Dec. 31, 2018. An improvement in investment performance, which we have incorporated in our forecasts, sets the scene for more stable fee revenue moving forward. The downside alternative will lead to earnings, and subsequently, fair value downgrades.

Operating expenses, a key theme for asset managers as the competitive landscape continues to intensify, were well-contained in the half, decreasing 7.5% from the pcp to around AUD 38 million. This was largely due to a decline in staff incentive expenses after an uninspiring first-half performance. Looking ahead, we expect Platinum to increasingly spend on staff retention to maintain investment outperformance and business development initiatives to enhance distribution and brand presence. Accordingly, we believe costs will continue to trend up over the long term, with our assumptions reflective of this. Of course, the perfect tonic to this is increasing FUM and improved performance.

At the heart of our investment thesis are our assumptions on future returns, which we believe will be the core driver of FUM. We have assumed a "through the cycle" market return of around 9% per year over the forecast period. Our research indicates emerging markets and international-developed equities, which has an outsize influence on Platinum’s core strategies, will outperform U.S. equities over the next 10 years because of more attractive relative valuation. We do not discount the potential instability in Platinum’s FUM given the eroding trust in vertically integrated advisor groups (who sell managed funds to retail-advised clients) post the Royal Commission, but we believe Platinum’s FUM growth should regain traction once the asset manager’s investment strategy plays out over time. Nevertheless, we assume zero net inflows throughout the forecast period given the extreme volatility of Platinum flows historically. We expect total FUM to increase by an average of 7% per year (after distributions) towards AUD 36 billion by fiscal 2023, driven by investment performance.