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Published 30 July 2012 06:32, Updated 31 July 2012 06:28
Fight back ... wealth management should be back on the radar of portfolio investors.
It has been a few years since this column looked at small- and mid-cap financial stocks. Apart from some discounted listed investment companies, it has been hard to get excited about wealth management equities whose earnings depend on the strength of the sharemarket itself.
Such stocks are often among the first to fall in bear markets and the first to rise as markets recover. Contrarians who believe the next bull market is likely in 2013 will see good value in higher-quality wealth management stocks, such as BT Investment Management, Challenger and IOOF Holdings.
I don’t share that view yet, but believe wealth management should be back on the radar of portfolio investors. Some might present an opportunity for long-term investors who snap them up during the next big market correction, take advantage of the high yield and can wait for the next bull market.
It is hard to find a short-term catalyst to re-rate most wealth management stocks. Commentators who expect a V-shaped sharemarket recovery this year or next will be disappointed. I’m surprised so many still refer to historic norms such as the average length of bear markets and bull-market patterns. A global financial crisis without precedent makes historic comparisons far less useful.
A recurring column theme has been to prepare for a long, grinding sharemarket recovery, punctuated by bouts of high volatility. Maybe we get the classic bear-market capitulation and waves of forced selling that lays the platform for the next bull market. I’m tipping at least another year or two of grind.
That scenario suggests even more retail investors leaving the sharemarket for the safety of fixed interest and cash, and greater declines in funds under management for many managers. Just about every fund manager and broker I talk to says retail investors are showing even less interest (if it’s possible) in investing in managed share funds or buying shares directly. And who can blame them after the hellish ride in global equities in the past few years.
The other challenge is valuation. BT Investment Management, for example, is on a price-earnings ratio of about 12 times 2012-13 earnings, consensus analyst forecasts show. That is hardly excessive for a well-run fund manager with one of the industry’s best brands, a controlling shareholder in Westpac that underpins its wholesale funds inflows and overseas earnings diversification through its acquisition last year of British fund manager JO Hambro Capital Management, which continues to report net fund inflows.
But BT’s valuation is not screamingly cheap either. There is a significant risk of more earnings downgrades from analysts for wealth management stocks, and the broader market for that matter. BT’s 7¢ dividend, fully franked, is an attraction, but not enough to rush into the stock just yet. The much larger Challenger offers better value.
It has fallen from a 52-week high of $5.07 to $3.25 and now trades on a forecast P/E of about 6.5 times 2012-13 earnings. A strong position in the annuities market is likely to attract retirees and conservative investors who continue to move from shares to fixed- or life-term annuities that provide guaranteed income returns.
Challenger has more risk than BT Investment or IOOF Holdings, which has grown strongly through acquisitions in recent years. Margin pressure in the life annuities business is a threat and Challenger might need to hold more capital to support its annuities operations and meet upgraded regulatory requirements. However, the stock is already pricing in plenty of bad news.
Arguably the best pick in the small-cap wealth management sector is the strongly performing Magellan Financial Group. Unlike most of its peers, Magellan shares have raced higher: its three-year average annual total shareholder return is 58 per cent. Magellan manages three global equity funds for wealthy retail investors and some global equities funds for institutional investors.
The Magellan Global Fund has exceeded its benchmark index by 10.7 per cent a year over five years – a stellar performance given so many funds manager underperform their index over long periods. Consistent outperformance has seen Magellan’s funds under management soar from $1.147 billion in June 2010 to $4 billion in June 2012.
Magellan has strong marketing and it is probably picking up funds inflows that would have gone to the doyen of international investing, Platinum Asset Management, which has performed poorly by its standards over one and three years. Platinum still has good long-term returns but Magellan’s investment team is clearly attracting plenty of new money for global equities investing.
If it continues, this momentum could further swell Magellan’s funds under management and earnings at a corporate level, which explains recent share price gains. And if it can increase its funds base strongly in a bear market, what could it achieve when markets improve and more investors return to global equities as the Australian dollar peaks and offshore equity markets eventually stabilise? As a small-cap stock, Magellan suits experienced investors.