International equities manager Magellan Financial Group Ltd (ASX: MFG) this morning revealed total funds under management grew around 2.5% over the month of June to hit a record $69.5 billion. I expect most of the around $2.2 billion in appreciation is down to the falling Australian dollar as the stocks held in most of Magellan's underlying funds are priced in U.S. dollars. As such the Australian dollar value of FUM lifts as the local currency weakens, with equity market appreciation also likely contributing a little to the strong result.
Of course not even Magellan's top dog Hamish Douglass can control the direction of global markets or currencies and as such investors must also consider the underlying operational performance of the business.
On this front it delivered two bits of positive news with institutional inflows of $214 million recorded for the month, alongside $4 million of retail inflows.
While the retail inflows are nothing to write home about they are significant in that they halt three consecutive months of retail outflows.
In addition the Magellan share price got hammered last week after sell-side researcher Morgan Stanley reportedly downgraded the stock to "underweight" and slapped a bearish $20 share price target on it.
A large part of Morgan Stanley's reasoning was reportedly the recent retail outflows, with the analysts believing Magellan will clock up $30 million in retail outflows in FY 2019 and FY 2020.
Morgan Stanley's thinking is reportedly that Magellan is suffering outflows due to its higher fees and other structural pressures, although I expect it has missed the biggest factor which is the downstream effect of the unusual way Magellan incentivised retail investors in its Magellan Global Trust (ASX: MGG).
Back in September 2017 existing shareholders were offered 6.25% in additional free MGG units above what they subscribed for in addition to the prospect of 6 cents in dividend payments by December 2018 for an offering at $1.50 per unit.
This was an astonishing and unprecedented giveaway that helped the group raise around $1.5 billion, but I suspect much of the retail outflows over April through June 2018 were retail holders selling out of the Magellan Global Trust to cash in on the generous incentives offered.
As such the raising may not have worked out like Magellan hoped for and it seems to me a much better way to grow FUM is acquisitively (e.g. with the Airlie Funds Mangement acquisition) rather than paying for it by incentivising retail investors, who then have the option to sell out after a short period of time.
If the retail FUM outflows are largely related to short-term issues around the Magellan Global Trust raising Morgan Stanley may be plain wrong in its assessment of the underlying business and future retail FUM flows.
Moreover, retail FUM flows are still not as important to a business where almost 75% of FUM is from institutional investors. In other words institutional business development is still the main game (albeit lower margin) for Magellan, where it is operating in huge addressable markets of institutional money looking for a home.
The institutional business development team appears to be ticking along nicely and if the retail FUM flows do reverse the stock ($23.50) is cheapish on 17x analysts' estimates for FY 2018's earnings per share of $1.40, with a trailing yield over 4% based on total expected dividends. The kicker being that Magellan is well positioned to deliver more strong growth for the first half of FY 2019 by virtue of the fact total FUM is already nearly 38% above where it stood this time last year.
Performance fees are another key driver of profitability with the group cycling off a weak H1 FY 2018 which it gives it a bit more potential to grow profits even faster.
Another factor weighing the stock down last week and others like Platinum Asset Management Limited (ASX: PTM) was traders selling the shares in anticipation of an upcoming market correction fuelled by the imposition of trade tariffs between the US and China last Friday morning US time.
However, selling in anticipation of a market correction is normally an amateur investing mistake as you will end up selling low and buying high ignorant of the market's perfect efficiency.
Despite the anticipated tariff impositions US markets rose strongly on Friday night and as famous U.S. fund manger Peter Lynch points out more money has been lost by trying to anticipate market corrections than in the corrections themselves.
Aside from market corrections, Magellan's main headwind is the rise of passive investing, although it still has plenty of growth levers of its own and critically remains a founder-led business capable of properly managing costs and resources.
As such I think it remains one of only two investment grade managers on the local market alongside Macquarie Group Ltd (ASX: MQG).
