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Magellan shares sink despite operating leverage growing on record $89.7b in FUM

The Magellan Financial Group Ltd (ASX: MFG) is down 2.7% to $57.12 this lunchtime with the benchmark index the S&P/ ASX200 (ASX: XJO) tumbling 2.6% as equities sink worldwide on the back of the ballooning trade war between the US and China. 

Today Magellan reported that its net funds under management (FUM) grew around 3.2% to a record $89.7 billion as at July 30 2019, with net inflows an impressive $574 million over just one month.

Total retail inflows were a strong $349 million although the fundie acknowledged this may in part be a result of dividend reinvestment plans. Institutional inflows totalled $225 million. 

The balance of the FUM growth around $2.4 billion over the month is due to appreciating equity markets and a falling Australian dollar.

The lower AUD is a powerful tailwind for Magellan as most of the equities it owns like Starbucks, Visa and Google are priced in US dollars so its AUD calculated FUM naturally appreciates as the local dollar falls. Additionally the vast majority of its operating costs are incurred in Australian dollars with its wages bill for local staff its biggest overhead. 

This is a nice Segway onto how operating leverage is an attractive feature of the Magellan business model.

Operating leverage is where revenues can rise faster than costs to produce strong profit growth. Magellan boasts this as FUM can appreciate $2.4 billion over the month of July for example due to rising markets while the business hardly has to incur any other costs.

It earns revenue as a fixed percentage of FUM (plus performance fees), so around 1.2% on $2.4 billion is around another $29 million in annualised revenue, but the fundie does not need any more staff to manage it. 

Magellan also has not debt and a strong balance sheet with cash or cash equivalent assets on hand of $451 million as at December 31, 2019. It also boasted a return on equity of 43.3% in FY 2018, to show how it’s a very profitable asset for investors to own. 

Of course since July 31 equity markets have tanked which is a serious risk for Magellan investors or those in other fund managers like Janus Henderson Group (ASX: JHG), Perpetual Limited (ASX: PPT) and Pendal Group Ltd (ASX: PDL).

As such it wouldn’t make sense to buy a fund manager if you are bearish on the short or medium term outlook on markets. 

Magellan will hand down its full year result on August 13, with investors expecting a strong result. Generally, I remain positive on the stock, but more conservative investors might want to wait until it reports its full year results before considering buying in. 

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Tom Richardson owns shares of Magellan Financial Group and Visa.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Alphabet (A shares) Starbucks and Visa. The Motley Fool Australia has recommended Alphabet (A shares). 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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