Australian asset managers will have to fight for future fund flows, according to Morningstar, as it identifies two of the seven across its coverage as being undervalued.
This is due to the influence of structural inflows going into ETFs and industry superannuation funds which has caused the pool of funds for active asset managers to shrink.
The ratings house covered GQG, Challenger, Insignia, Magellan, Perpetual, Pinnacle and Platinum, and said it expects funds under management (FUM) and earnings to recover from the lows of fiscal year 2023 with some revival in investor interest expected once interest rates fall.
However, performance will be insufficient to reverse the share of funds lost to passive funds, especially for boutiques like Magellan and Platinum.
GQG and Pinnacle were re-rated followed by Challenger which all saw share price gains. Insignia, Magellan, Perpetual and Platinum saw their share prices decline; Morningstar is concerned about organisational issues and the impact of interest rates and inflation being less favourable for them than initially expected.
As of 26 June, shares in Platinum are down by 37 per cent over one year while Insignia is down by 19 per cent. In contrast, GQG Partners is up by 101 per cent.
Equity analyst Shaun Ler said: “This expectation [of rate cuts] has already led to some pre-emptive recovery in flows and investment returns in fiscal 2024. However, we anticipate the average earnings growth to subside in the medium term due to fee compression, cost inflation, and as the rate of net flows normalises.
“While GQG has strong performance, experience with Magellan and Platinum suggests it is hard for boutiques to maintain an edge in the long term. Diversified firms like Insignia, Challenger, Pinnacle and Perpetual tend to deliver more consistent, balanced overall track records. But they lack the flow upside of GQG, given the competition.
“We estimate the retail and wholesale share classes for this cohort of seven firms that have, on average, delivered rather average peer-relative returns. This is unlikely enough to regain the share lost to ETFs and industry funds.”
Regarding fees, Morningstar said all active managers likely need to trim pricing in order to counter competition from passives with further fee margin compression expected. This will be “most acute” for Magellan and Platinum, while Insignia will compress at a slower rate as its products are already priced below active peers.
Undervalued asset managers
The asset managers that the firm concluded as “undervalued” are Insignia and Perpetual. Insignia because of the aforementioned fee compression, and Perpetual because it should benefit from interest rate reductions.
“We believe the market underestimates Insignia’s ability to stabilise earnings, with cost-outs counterbalancing tepid revenue declines. There is still ample room to remove duplicate or non-essential costs to extract scale efficiencies. Moreover, we think revenue will decline in the long term but at a manageable rate. This reflects our expectation for a slower compression in fees, and likely improved fund flows over the medium term.
“As administered funds increase, cost synergies are extracted, and as operating margins stabilise, debt serviceability should improve. We think the odds of multiple expansion are good at current prices, particularly if outflows lessen and margins stabilise.”
The research house previously stated that Insignia’s advice restructure could solidify its reputation amid a declining share price and new CEO.
For Perpetual, which recently entered into a scheme of arrangement to sell its wealth management and corporate trust to private equity giant KKR, Ler said he hopes this will remove duplication in the business.
“We believe the market is overlooking Perpetual’s likely earnings recovery from cost cuts and better flows. While the investments business is in net outflow, potentially lower interest rates should help reduce redemptions, which are presently cyclically elevated. There is also room to centralise operations and remove duplication given the Pendal acquisition.
“Elsewhere, we anticipate improved volumes for wealth management and corporate trust with stabilising interest rates and potential macroeconomic improvements. Both segments face less competitive intensity than investments. The proposed acquisition of both these businesses by KKR vindicates our view that their values are not reflected in the current stock price. Wealth management and corporate trust make up close to half of our fair value estimate, excluding corporate costs.”
