Magellan Financial Tests The Faith

This story features MAGELLAN FINANCIAL GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MFG

More than a few eyebrows were raised yesterday when Magellan Financial Group's September quarter data revealed a dramatic outflow of funds

-Cracks showing after a year of underperformance at Magellan Financial Group
-Hard to stage a comeback from here – but not impossible
-Pressure expected to remain for several quarters

By Sarah Mills

More than a few eyebrows were raised yesterday when Magellan Financial Group ((MFG)) announced its September quarter funds under management (FUM) data. 

FUM fell -$4bn to $84bn in its Global Equities fund after investors switched allegiances in response to the fund’s poor performance.

Net institutional outflows rocketed to -$910m in the September quarter from -$91m in the June quarter as three clients rebalanced portfolios; and retail outflows jumped to -$617m from -260m. 

Net flows in other segments were stable.

Most of the outflows were clocked in the month of September, so while FUM rose 11% on the previous year, it fell -$600m in September.

Credit Suisse suggests the outflows in isolation are only likely to reduce earnings by only -1% to -2% in FY22-24.

But should investors turn tail in search of greater opportunity, or should fees be reduced, both would result in material falls in earnings per share. 

Morgans reports that every -10 basis point fee reduction translates to a -3.8% fall in EPS but says a fee reduction is unlikely for this very reason.

While Credit Suisse expects institutional investors will continue to support the stock given downside protection, the broker expects this to be outweighed by redemptions relating to weak performance.

Key drivers suggest pressure on fees

The outflows reflect a year of underperformance. The fund has posted its worst run on record, underperforming the benchmark in 10 out of 11 months, reports Macquarie.  

Credit Suisse reports the Global Fund’s has under-performed by about -19% over one year.

About 23% of net retail outflows relate to redemptions from the High Conviction Trust when it was converted to an open-end active exchange-traded fund, providing an opportunity for investors to exit.

At face value, this is likely a one-off occurrence, but sentiment could snowball.

Credit Suisse doubts retail outflows will slow, forecasting continued deterioration over the next three years.

Nearly all brokers believe the likelihood of continued outflows means the pressure on the fund to drop performance fees this half is very high.

Morgans reports Magellan’s fees are at the upper end and less defensible given underperformance.

Magellan explains

Magellan advised the market that FUM flows no longer drive the economics of the business and that absolute performance is, instead, the unit holders’ focus.

That may be the case, but sentiment often has little to do with economics and sentiment can be powerful driver in an uncertain share market.

In its defence, the fund points out that it lost no institutional mandates in the quarter of FY22, and has gained its first two mandates for its new Sustainable strategy.

Ord Minnett expects Magellan’s best-in-class distribution function will be tested as it defend its funds under management as will its investment style of attracting low downside capture.

The broker suspects that the fund might be best off using its dividend reinvestment plant to reinvest in the share price rather than add incremental capital.

Outlook weak as challenges compound

Most brokers spy strong valuation support, but expect consensus downgrades as negatives compound and are likely to be unavoidable should performance fees be lowered.

Investor fatigue, continued pressure on outflows and pressure on performance fees could feature during the FY22 first-half.

Most expect no revival for several quarters.

Morgans reports lack of traction in strategies to drive FUM growth and growing fee pressure, but sees fee reductions as unlikely.

Still, things can turn on a dime

The fund has been purchasing deeply discounted growth companies in a year of rotation out of growth and into value. A reversal in FY22 could revive fortunes.

But the falls are set against high market uncertainty; the Fed intimating rate rises as supply-driven inflation hits the economy, deleveraging in China as the Evergrande concerns weigh on the market; and a flood of global debt.

During FY21, the fund invested in investment bank Barrenjoey, financial services provider FinClear and food chain Guzman y Gomez.

So the majority of brokers have plumped on the side of caution, despite nearly all appreciating the stock’s low valuation (the stock is trading on a price-earnings multiple of 13x).

Fund manager WAM Capital ((WAM)) recently bought in to the fund for that very reason.

Forecasts vary sharply

Macquarie was the notable positive exception, upgrading the fund to Outperform from Neutral citing the 7% dividend yield and downside protection, but has cut its target price to $38.00 from $46.75.

The broker describes the fund as bent but not broken, expecting one-year metrics should improve after November but still underperform benchmarks.

Morgans downgrades from to Hold from Add, and cuts its target price to $42.85 from $54.85, waiting for sentiment to play out before committing.

Ord Minnett retains a Hold rating and cuts its target price to $36.00 from $48.50.

Credit Suisse retains a Neutral rating, expecting the Global Fund will continue to underperform and reduces the target price to $35 from $37.

Morgan Stanley retains its Underweight rating and $34 target price. 

UBS retains its Sell rating and lowers the target price to $29 from $35.

The FNArena broker database is split two Buy, two Hold and two Sell (or equivalent) ratings. A consensus target of $37.81 suggests 17.8% upside.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms