Why I'd buy Magellan shares for my SMSF today

What are the best shares for an SMSF?

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Earlier in the week I wrote how the first two shares I'd stick in my SMSF (if I had one) are Macquarie Group Ltd (ASX: MQG) and CSL Limited (ASX: CSL).

Aside from their high quality, moats, reliable dividends, and superb track records, both these businesses also offer excellent liquidity (if I wanted to invest a few hundred thousand dollars in each) and overseas exposure.

Another business I've regularly recommended as a buy to readers over the past 5 years or so is international equities manager Magellan Financial Group Ltd (ASX: MFG).

I first picked up the stock for $10.60 in January 2014 and since then it has gone onto more than quadruple including dividends and I expect it would be a good addition to my SMSF today.

That's because the fundamentals of the business remain the same in that it is founder led, carries no debt, and boasts excellent operating leverage.

I've also written tens of thousands words previously on how its institutional business development and retail distribution functions appear to work better than any other fund manager on the local market.

Just today it reported net funds under management (FUM) inflows of $1,177 million including net institutional inflows of $820 million.

I've covered before why retail FUM is higher margin, but for a fund manger like Magellan institutional business remains the key opportunity thanks to the eye-watering size of the market globally.

According to Willis Towers Watson the world's top 20 pension funds are worth US$7.4 trillion (US$74,000 million), while a university like Harvard has a US$36 billion endowment fund alone.

In Australia Magellan is generally now regarded as a large fund manager with $79 billion under management, but in the UK or US for example it would have not much more than boutique or mid-size status.

In other words it still has an almost infinite growth runway in gathering FUM, assuming this is the logical path it follows, with only A$58 billion in institutional FUM currently.

To be clear I'm not saying Magellan can be the next Blackrock, but at the same time there's no reason why it can't double that institutional FUM again in the five years or so.

Institutional business development (IBD) generally involves pitching potential clients such as private / public pension funds, charities, or universities and their teams of investment consultants.

Generally, institutional clients and their advisers will look to the 5-year investment track record of a fund and towards the latter stages of a pitch (after initial engagement from request for proposal and IDB teams) a fund manager and the CEO will also seek to persuade potential clients to offer a mandate.

Magellan with Hamish Douglass's growing persona, a strong investment track record, and seemingly slick presentation process has a good track record of hauling in FUM.

Moreover, as I've flagged more recently as its scale grows FUM flows become less relevant to market and currency movements, alongside investment performance.

For example a 2% appreciation in FUM due to market movements is now worth nearly $1.6 billion to Magellan, which is an amount far greater than average monthly FUM flows.

As it scales its operating leverage should also magnify as revenues (via fees on exponentially growing FUM) rise faster than costs that should stay relatively fixed.

For example if you're running a theoretical $5 billion fund it'd be standard to have a lead fund manager, assistant, and team of supporting research analysts who also worked supporting other funds.

However, even if the fund size doubled to $10 billion you wouldn't need to hire another lead fund manager or assistant, and not even anymore research analysts unless you chose to.

Other areas such as clients services, dealing, compliance and outsourced back office costs would of course grow as you scale, but again not as fast as revenue or profit growth in theory.

As such I'd be happy to add Magellan into my SMSF today for dividends and a little growth via its exposure to the blue-chip end of U.S. equity markets.

Motley Fool contributor Tom Richardson owns shares of CSL Ltd., Macquarie Group Limited, and Magellan Financial Group. You can find Tom on Twitter @tommyr345 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 Scott Phillips.

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