The Wrap: Fund Managers, Lockdown Habits, Gas & Banks And Bond Yields

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Weekly Broker Wrap: Fund managers; lockdown habits; gas; banks and bond yields

-The fund manager most deserving of your money
-How lockdown habits have evolved into trends
-The gas opportunity in Western Australia
-Favoured banks and non-banks after the bond yield move

By Mark Woodruff

The fund manager most deserving of your money

The rise of passive funds remains a formidable threat to listed fund managers, according to UBS. This will likely result in substantial fee compression and/or volume loss, particularly for serial underperformers with high fees.

The broker has increased its coverage of fund managers and initiated research on Pendal Group ((PDL)), Perpetual ((PPT)) and Platinum Asset Management ((PTM)) with ratings of Buy, Neutral and Sell respectively. A Sell rating for Magellan Financial Group ((MFG)) remains unchanged.

UBS points out Australian retail fund flows should continue to be supported by ample liquidity and low rates. While the largest beneficiaries of these flows will likely be passive strategies, active outperformers with below-average pricing and thematics such as ESG should do well.

The broker is positively disposed towards Pendal Group as its investment performance remains robust, its fees are reasonable and distribution is improving. Moreover, the group’s shares are well priced and offer an attractive dividend yield. With cyclical tailwinds, the analysts can envisage a 15-20% share price re-rate once net flows become positive. The broker starts with a 12-month target price of $7.95.

More awkwardly, Magellan Financial Group (target price $29.50) appears to combine above-average fees with sub-par performance, which UBS feels may result in external pressure to lower base management fees. The group’s Global Fund has underperformed the benchmark by around -20% over the last year.

Similarly, the broker points to uncompetitive fees at Platinum Asset Management (target price $2.55) and suspects rebuilding from a decade of underperformance will take time. 

Finally, Perpetual’s execution on distribution is considered key by UBS to deliver the consistent net inflows needed to justify a re-rate. While the analyst is supportive of the current investment performance and flow trends, assisted by tailwinds for Value and ESG, there are concerns regarding the fund managers’ cyclical nature. The broker sets its target price at $36.80.

How lockdown habits have evolved into trends

Is it possible your habits developed during lockdown have subtly changed your perspective?

Apparently our view of hotel design has been altered by lockdown habits of working from patios and meddling with pot plants, according to a Hilton global trends report.

One would think such a global hospitality company is well placed to seize upon emerging trends for travelers, having welcomed more than three billion guests in its more than 100-year history.

Hilton believes needs and interests have indeed shifted as a result of the pandemic, and people are likely to prioritise reunion and reconnection travel in 2022. Outside of this, there is likely to be a trend toward sustainability and community, and thus loyalty to brands, companies and organisations that align with these values.

The Hilton report also reveals the home baking trend is resulting in more demand for culinary adventures, while there is rising demand for low-to no-alcohol beverages. 

Finally, we have embraced efficiencies in many aspects of our lives life and will now be demanding such things as contactless check-in and digital keys. 

The gas opportunity in Western Australia

Credit Suisse points out the potential for tighter market conditions in the Western Australian gas market may present an opportunity for equity investors.

Having just lifted gas price assumptions to $6/GJ from $5/GJ, the broker considers prices above $8/GJ are very plausible.

While Strike Energy ((STK)) has far greater leverage to these price movements, it also has risks attached to exploration. As a result the analyst considers Beach Energy ((BPT)) a safer play while still having five times the leverage of Santos ((STO)). The latter has contracted out much of its WA production, admittedly at strong legacy prices, explains Credit Suisse.

Meanwhile, Woodside Petroleum’s ((WPL)) exposure remains limited given its export commitment.

For numerous reasons, Credit Suisse believes prices may materially tighten over the next decade, leading to a divided WA gas market. Government policy may dictate cheap gas from new supply developments is directed to underpin new manufacturing. At the same time existing gas buyers may be left to compete against much higher LNG netback parity pricing (the equivalent export price) for the remaining volumes. 

Some investors may be lulled into a false sense of security as half of the market supply arises from the state government’s domestic market obligation’ (DMO) policy. This requires LNG projects to deliver 15% of their gas to the domestic market.

However, analysis by Credit Suisse of supply-demand imbalances indicates the market may tighten nonetheless. Moreover, the possibility of further LNG export exemptions could place material upward pressure on pricing.

Favoured banks and non-banks after the yield move

Citi analyses the effect of the recent rise in bond yields upon banks and non-banks and outlines its preferred equity investments.

As benchmark rates for durations of more than one year have mostly been impacted, this has relevance for bank funding costs and the flow on effect to mortgage interest rates.

While funding costs for fixed rate mortgages will rise (higher swap costs), there should be little change for the variable rate products (the majority) that are funded at the short end of the curve, explains Citi. As a result, the analysts think it is too early to call the end of ultra-low mortgage rates, though there will likely be a dramatic end to the 12-month surge in the popularity of fixed rate products.

Moreover, the level of activity in the housing market and house prices are expected to remain supported by competition in the mortgage market, though with increased focus on variable rate products.

Morgan Stanley points to evidence of increased competition in mortgages from the margin headwinds evident in recent results from Bank of Queensland ((BOQ)), ANZ Bank ((ANZ)) and Westpac Bank ((WBC)).

While the RBA has walked away from yield curve control, a few other factors are keeping rates suppressed at the short end of the curve, which assists bank funding costs. These include (business and household) deposits now comprising a record proportion of banks’ total funding mix (due to fiscal stimulus).

Morgan Stanley feels this ongoing strength in household deposit growth will continue to provide funding tailwinds for the banks into the first half of 2022.

Under these conditions, the broker has a preference for the non-bank financial institutions (NBFIs). Despite benefiting from short-end funding and growth in addressable market, the share prices of NBFIs have still sold off relative to other participants in the mortgage market. Australian Finance Group ((AFG)) and Liberty Financial Group ((LFG)) are Citi’s preferred exposures.

Meanwhile, from among the larger lenders, Citi likes Macquarie Group ((MFG)), which has largely stayed out the fixed rate market.

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