The Australian Ethical Investment Limited (ASX: AEF) share price is falling today after the ethical investment manager posted its profit result for the six-month period ending December 31 2016. Below is a summary of the result with comparisons to the prior period.
- Net profit of $0.564 million, down 62%
- Underlying profit of $2.3m, up 52%
- Net profit impacted by $2.2m cost of remediating unit pricing error
- Revenues of $13.3m, up 22%
- Operating expenses of $10.1m, up 19%
- Fully franked interim dividend of 50cps
- Total funds under management of $1.84b
- Net inflows of $209m, up 35%
- Superannuation members at 30,535 (up 30%)
- Flagship Australian Shares Fund beat its benchmark
On an underlying basis this was another impressive result from Australian Ethical, with an astonishing exception for the $2.2 million cost incurred for fixing unit pricing errors in its superannuation fund.
In total the group is to effectively refund members of the fund $1.945 million that is owed to them due to the unit pricing error that clearly went undiscovered for a significant amount of time.
A general principle in this kind of situation is that in the event of a loss a client must be put back in a position they would have been but for the error, while if a fortuitous gain occurs as a result of an operational error who retains the gain may vary depending on the circumstances. In Australia there is still a lack of regulatory prescription over the issue, although generally it's accepted that if clients' funds were employed in creating the fortuitous gain they may be entitled to its benefits.
AEF flagged that it is beefing up its operational risk and compliance resources as a result of the error and it's worth noting that operational errors like this are far from always being isolated, which means the firm has work ahead to restore investor confidence.
Recently larger fund manager and administrator IOOF Holdings Limited (ASX: IFL) was busted for brushing its operational errors under the carpet in failing to notify the regulator ASIC of them as required by the corporate cop's regulatory guides.
Outlook
If you assume AEF's almighty unit pricing cock-up is a one off, the group ticks the boxes as a fund manager in the sweet spot of growing FUM while producing decent investment performance. This combination can compound growth as a strong track record of investment performance understandably impresses retail investors and their advisors, while AEF potentially has another growth lever in winning institutional business if it is able to scale up over time.
Overall, the trend towards ethical investing is a powerful tailwind supported by Australia's ballooning superannuation pool, although AEF has competition from many powerful rivals like AMP Limited (ASX: AMP), Perpetual Limited (ASX: PPT) and Colonial First State as the investment management arm of the Commonwealth Bank of Australia (ASX: CBA).
Recently the innovative international equities manager Magellan Financial Group Ltd (ASX: MFG) tapped into the capitalist zeitgeist by announcing it was seeding three "low-carbon" funds for institutional investors keen to add some environmental credibility to their reputations and investment strategies. Commonly institutional investors are huge pension, government sector, union, charity, or faith funds for example that like to demonstrate their social responsibility to their investing members.
Evidently AEF has some stiff competition and is probably best served by continuing to distinguish itself from larger rivals as an independent asset manager solely focused on ethical investing, rather than one that includes it while also investing in fossil fuels and whatever else it owns of a dubious nature across its multiple other funds.
I continue to like its outlook but feel the share price at $91 is not reflecting the substantial damage sustained by the $2.2 million operational loss even accepting it as a one off event. Even if you exclude the loss it earned $2.11 in earnings per share in the the most recent half-year period which would place on it 21.5x annualised earnings. This is still a little high for my liking even though the group is growing at a decent rate from a small base.
