Cash Squeeze Looms For Specialist Platforms

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Specialist fund platforms continue to benefit from disruption, taking business from the majors, but brokers point out a squeeze on cash accounts looms large amid further cuts to official interest rates.

-Large platforms carry uncertainties around remediation and regulatory actions
-Yet small platforms face elevated margin pressure
-And downside risk to pricing as cash rates head lower
 

By Eva Brocklehurst

Trends in flows on specialty fund platforms remain highly divergent and June 2019 represented the fourth consecutive quarter of outflows for the industry. Previously, inflows occurred in every quarter for the past 15 years. with one small quarterly exception in 2012.

However, Credit Suisse points out June quarter outflows were less severe than in the prior quarter, which was the lowest in the 15-year time series. All funds experienced growth in funds under administration, with the slowest being assets in retail funds. Industry funds received around 90% of total net flows.

Recent themes continue, including major banks and AMP ((AMP)) losing share to industry funds and specialists. Retail funds lost -1.1% in market share over the quarter, the biggest market share loss in the broker's time series since 2005.

Specialist platforms such as Netwealth Group ((NWL)), HUB24 ((HUB)), Praemium ((PPS)), OneVue ((OVH)) and Xplore Wealth ((XPL)), have increased total market share to 5.5% as of June. Netwealth and HUB24, which have wider broker coverage, gained 0.18% and 0.11% market share, respectively.

Those large cap platforms that retreated include AMP, down -0.19%, and National Australia Bank ((NAB)), down -0.11%. Flows into personal superannuation products also now exceed those into investment products.

Another contributor to net flows is the benefit payments from pension phase accounts. Retail funds are experiencing benefit payments, Credit Suisse observes, at levels 75% above industry funds. Around 34% of retail funds under administration are in the pension, or drawdown, phase, while only 10% of industry funds are at the same stage.

Meanwhile, in 2019 to date there has been a -12% decline in total financial advisers. HUB24 and Netwealth continue to benefit from disruption in the market and industry funds remain beneficiaries of the bulk of money, as retail platforms compete over fees and the small residual flow.

Large-capitalised platforms, such as IOOF Holdings ((IFL)) and AMP offer valuation appeal, Credit Suisse suggests, but also carry uncertainties around remediation costs and the impact of regulatory actions. On the other hand, small-cap platforms, such as HUB24 and Netwealth, face elevated revenue margin pressure. Hence, the broker prefers the large caps.

UBS expects Netwealth, as a percentage of assets under management, and Magellan Financial Group ((MFG)) will lead the way in terms of net flows among fund managers, while IOOF will also experience positive flows. Assets under management for both Netwealth and IOOF are likely to be boosted by stronger equity markets, in the broker's view.

Netwealth and HUB24 net flows should continue growing, Citi asserts, driven by market share gains as well as an improvement in adviser activity. Both remain beneficiaries of the structural shift to specialty platforms, but there is downside risk to overall pricing as cash rates head lower.

Rate Cuts

Citi points out interest rates on platform cash accounts have been lowered by -25 basis points in line with the cut to the Reserve Bank of Australia's official rates. Netwealth, HUB24 and BT Panorama have all lowered rates, and margins remain at risk from any further reduction to the cash rate.

Citi economists expect the RBA to cut by another -25 basis points in February 2020 and, technically, Netwealth and HUB24 could maintain the cash margins by lowering the rate on cash accounts to zero. Forecasts assume a -15 basis points impact on cash administration margins from the fourth quarter of 2020 onwards.

The reduction in the official cash rate leaves a majority of account holders on HUB24 and Netwealth platforms with negative cash returns, net of administration fees. Macquarie envisages little ability to offset the impact, and calculates sensitivities for an annualised -25 basis points squeeze on cash FY20 earnings per share of -14% for HUB24 and -9% for Netwealth.

Classifying pooled capital as retail deposits also represents additional downside risk for the specialty platform providers. HUB24 and Netwealth offer higher risk in this regard relative to other industry platforms. The broker reminds investors that Netwealth in FY19 generated operating earnings margins of 52.6% for a 2.5% market share.

Macquarie remains concerned about the sustainability of cash spreads and associated fees and also believes macro conditions present unprecedented pressure for platforms.

Credit Suisse points out cash administration fees are significant contributors to Netwealth and HUB24 earnings. This makes them very sensitive to cash allocations. The broker expects cash administration fees will face pressure over the long-term as allocations decline and advisers look to use cash alternatives, such as term deposits and cash ETFs (exchange traded funds), that have a similar risk profile but better returns.

On the FNArena database Morgans covers Praemium, with an Add rating and $0.59 target. Netwealth Group has one Buy, for capital and one Sell rating. The consensus target is $7.68 signalling -13.9% downside to the last share price. HUB24 has one Buy rating, three Hold and one Sell. The consensus target is $12.44, suggesting 4.7% upside to the last share price.

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