Señor Ferdinand Magellan the sailor was a Portuguese explorer who reputedly organised the first circumnavigation of the earth around 500 years ago. The eponymous fund manager, Magellan Financial Group Ltd (ASX: MFG) has been charting its own route to success recently and looks a ship with potential to deliver the goods to investors.
On Friday the fund manager posted an FY14 net profit up 71% to $87 million when you back out a one-off gain included in FY13's results. For the year funds under management grew from $14.6 billion to $24.8 billion, as another year of strong net retail and institutional inflows supported by rising global equity markets took effect to produce the FUM lift.
Alongside investment performance the key growth driver for Magellan is the level of fund inflows with $5 billion of new institutional mandates won over the year and $2.1 billion of retail inflows. As with most fund managers, institutional business development is key with the large UK, US, and Canadian markets now the prime sales targets. Notably the group had a great start to FY15 adding $1.17 billion in net institutional inflows in July thanks to some big institutional business wins.
However, investment performance this year was disappointing with the flagship Magellan Global Fund (MGF) underperforming the MSCI World Net Total Return Index and S&P 500 Index. This was reflected in a 93% drop in overall performance fees (unlikely to be won if you don't beat the benchmark), although the 137% rise in management fees due to FUM growth more than compensated for the disappointing investment performance.
Nevertheless the MGF has outperformed the above mentioned indices over three and five-year time horizons and this is significant as investment performance is one of the key pillars an institutional business development team will rely upon to win new global mandates. When you're presenting to investment consultants and potential new institutional clients the past performance slides are a key part of an overall sales pitch delivered in an extremely competitive market.
Like the sailor probably did, Magellan the fund manager runs a tight ship with a crew of just 69 employees unlikely to include any passengers. This is reflected in a low cost base that enables it to enjoy high returns on equity and operating leverage. In other word revenues through FUM growth can rise far quicker than expenses, although the crew is expected to increase in size by 30-35% this year. Notably this suggests the crew's commander, Hamish Douglass, is confident in the outlook.
The heavy emphasis the fund manager places on sales and distribution is reflected in the fact that more than one-in-four total staff are directly involved in the sales and distribution effort.
Head of Distribution is the well-connected, Frank Casarotti, who has been cranking the retail inflows for Magellan ever since leaving his previous role as Head of Adviser Distribution at Colonial First State (CFS), the wealth management arm of the Commonwealth Bank of Australia (ASX: CBA). The MGF benefiting from its position on the popular CFS FirstChoice Investments platform in part because it allows retail investors to diversify away from Australian equity exposure.
Magellan the sailor also likely appreciated a good tailwind or two in his time and in the growing pool of superannuation funds held by retail investors the fund manager appears to have at least one long-term tailwind. The other tailwind it has enjoyed recently, rising global equity markets, is sure to turn sometime in the future at which point the crew can expect the going to get tougher.
Australia-based global equity managers also suffer one other permanent disadvantage, Australia's isolated time zone, unless working 9 – 5 takes on a whole new meaning (9pm – 5am), Australian equity managers will generally be out of the office when European and US markets are trading.
Selling for $12.84 after Friday's announcement the good ship Magellan trades on 26 times FY14's earnings but on a low price-earnings to growth (PEG) ratio of 0.33, this based on 67% earnings per share growth after adjusting for FY13's one-off gain.
For the stars to align in FY15 Magellan will need the gods of the equity markets to oblige, while a strong year of institutional business development or investment performance will make the group look undervalued at today's prices. A strong year in both and it will look substantially undervalued in my opinion. However the risks remain that it suffers from a slowdown in FUM growth, falling equity markets, or weak investment performance.
