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Why Perpetual Limited shares look a sell

The share price of fund manager and financial services provider Perpetual Limited (ASX: PPT) has moved higher in morning trade after the group delivered an interim underlying profit of $63.4 million on operating revenue of $240.7 million.

The group is split into three operating areas of a private wealth advisory business, corporate trust business and its core funds management business.

The underlying profit result was just 2% higher than the prior corresponding half in a result the group blamed on lower equity markets, although it would be better off looking at anaemic net fund inflows of just $100 million for its funds management division for the six-month period.

Institutional funds again headed out the door over a period characterised by mediocre investment performance as the group’s reputation for stock picking strength looks dubious given some of the recent holdings it has disclosed.

These include a substantial holding in an estate agent in Mcgrath Ltd (ASX: MEA). It was down around 18% on its full year results yesterday and if your fund manager is charging you fees to invest your cash in real estate agents, you might want to think about getting another fund manager.

Perpetual also held a substantial holding in troubled law firm Shine Corporate Ltd (ASX: SHJ) prior to its 70% price crash. It also surprisingly choose to add to this holding after the price falls.

It is also a substantial holder in electronic car parts business Infomedia Limited (ASX: IFM), which has also plunged in value recently on profit falls and a tough outlook. As at the end of January the group’s flagship Australian Share Fund is down 7.8% over the last six months and has returned just 3.3% over the past three years. The feeble returns a worry for a group that relies heavily on its reputation.

CEO Geoff Lloyd deserves credit for promoting Paul Skamvougeras to his position as head of equities despite a slightly unconventional career path to the role, although if the group’s reputation for investing strength waivers amongst consultants and the wider investing public then there could be trouble ahead.

Another large hole in the investing case for Perpetual remains its weak institutional business development and retail distribution results that mean it is unable to consistently grow FUM unlike superior investment managers like Magellan Financial Group Ltd (ASX: MFG).

Geoff Lloyd has enjoyed success in lifting the share price, but that was from embarrassing lows in 2012 and largely by virtue of cutting costs rather than delivering strong growth.

In fact the group’s board reacted with glacial like pace to the reality of GFC – only embarking on cost-cutting measures around 3 years after the GFC’s lows and it has only just woken up to the growth opportunity in international equities.

Don’t hold your breath waiting for the international move to deliver meaningful returns either, as the international equity space is competitive where credibility and a long track record counts for a lot.

Perpetual then really needs to ramp up its international growth efforts if it is serious in challenging big-hitting rivals, rather than making small moves that do little to alter the overall outlook.

However, the funds management division’s cost-to-income ratio already stands at 48%, which is high compared to more investment grade rivals and again shows weakness in the underlying business as it is unable to consistently grow despite having a far higher cost base relative to superior rivals.

Perpetual’s private wealth advisory business also saw profits drop on higher costs and soft equity markets, while the corporate trust business delivered some growth as it benefits from the tailwinds of the Trust Co acquisition and new management it brought with it.

Overall, Perpetual shares do not look a good long-term investment as the group still has a relatively high cost base, no real competitive advantages, and the significant downside risk that its leverage to Australian equity markets brings.

In fact, if I owned Perpetual shares I would sell them and look to buy some businesses with big growth prospects on attractive valuations, just like the three below…

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Motley Fool contributor Tom Richardson owns shares of Magellan Financial Group.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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