More Mandate Losses Expected For Magellan

This story features MAGELLAN FINANCIAL GROUP LIMITED. For more info SHARE ANALYSIS: MFG

Funds underperformance this year has led to Magellan Financial Group losing its biggest client, and brokers suspect this is just the beginning.

-Annus horribilis for Magellan Financial
-Big mandate loss likely triggers further redemptions
-Most, but not all, agree the stock is no-go for the time being

By Greg Peel

Any ad you might see for a funds manager always comes with the caveat “past performance is no guarantee of future performance”. Not for no good reason.

Up until covid hit, Magellan Financial Group ((MFG)) was the darling among listed funds managers in Australia, putting in stellar returns performances when all about were struggling, and attracting solid inflows as a result. From the end of 2018 to the beginning of 2020, Magellan’s share price rose 186%.

Over the same period, the ASX200 rose 24%. However, Magellan’s flagship is its Global Fund, and foreign institutions clients make up the bulk of clientele. Thanks to its strong performance, Magellan was able to charge market-leading performance fees to both institutional and retail clients.

From that January 2020 high, Magellan shares have now fallen -70%, including -33% last Friday. One single year of funds underperformance has wiped out the manager’s ten-year “alpha”, UBS notes, (relative market performance), and this will now be carried for a long time before it rolls off.

Earlier this month, Magellan’s CEO suddenly walked, leaving no succession plan. This was not a positive sign for investors.

The big share price fall on Friday came after Magellan lost its biggest mandate. Institutions mandate funds managers to manage an amount of their own funds. The St James Place mandate was worth 12% of Magellan’s revenues. The next three largest mandates together represent 10%, Macquarie notes.

Conga Line?

When a stock falls by such a magnitude in one day this often elicits calls of “oversold” by brokers, on the simple stairs & elevators principle of market panic. But not for Magellan, among FNArena database brokers.

Macquarie held the only Buy or equivalent rating (Outperform) on Magellan ahead of Friday, and despite the -33% plunge has downgraded to a Hold equivalent (Neutral). Morgans has retained its Hold rating and UBS and Morgan Stanley retain their Sell or equivalent ratings.

(Note Ord Minnett and Credit Suisse each have Hold or equivalent ratings, but this week shut up shop for the year.)

Brokers agree the loss of the St James Palace mandate will likely not be the last.

There is an expression in markets: there is never only one cockroach. If you see one, you know there’ll be more about.

Moreover, Magellan will have little choice but to reduce its market-topping performance fees in order to stem 2021’s persistent funds outflows. An improved funds performance wouldn’t hurt either.

Consensus has risk persisting to the downside at this point, albeit downside potential is limited given the big share price plunge, not just last week but all year. At the moment, the call is “steer clear”.

The consensus target price for Magellan has fallen to $24.94 from $37.11. However, that includes Ord Minnett and Credit Suisse, with unchanged targets. If we take the average of the four brokers updating, their consensus target has fallen to $19.66 from $34.91.

Voice in the Wilderness

Morningstar, not an FNArena database constituent, agrees the St James Palace mandate loss could trigger further fund redemptions, and that near term earnings and share price catalysts are limited.

However, Morningstar declares Magellan shares to be “materially undervalued”.

The research house notes there is a current structural trend of investors shifting away from active funds managers towards passive investment (either through a passive index fund or ETFs) as well as competition among the fund managers and institutions, who might otherwise hand the likes of Magellan a mandate, to move their asset management in-house.

Morningstar does not believe Magellan is immune to these trends but believes it’s better-placed than most active managers to address the headwinds, noting the fund manager is moving beyond just managing money towards implementing new initiatives such as product expansion to attract new money.

Morningstar does not provide standard Buy/Hold/Sell style ratings nor twelve-month target prices. It has nonetheless cut its fair value estimate by -25% to $38.00, implying a prior fair value estimate in excess of $50 compared to the FNArena database prior consensus target of $37.11.

That said, Morningstar rates Magellan’s “Fair Value Uncertainty” as High, and its “Moat Rating” as Narrow.

The wider the moat, the greater the barrier to entry for prospective players, which clearly is not the case for funds management.

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