Magellan Financial Group Ltd

While we don’t believe it will be immune from the structural trend of investors moving to passive investments, ongoing competition among fund managers and major institutions in-housing their asset management, we think it’s better placed than most active managers to address these headwinds. Magellan is moving beyond passively managing money, to implementing new initiatives such as product expansion to attract new money. There are prospects of stronger inflows, notably from Australia’s self-managed superannuation funds, the ageing demographic, and fee-conscious investors who were previously discouraged from investing with Magellan. However, continued strong performance will remain key.

Magellan has built a high-profile brand that it can effectively leverage to attract/retain client funds.
The firm is well placed to serve growing retail investor demand and win institutional mandates. In Australia, increasing superannuation balances supported by the ageing demographic and compulsory superannuation should expand demand for its products. Meanwhile, its established presence in the much larger U.S. and U. K. markets provides further growth opportunities.
A strong balance sheet, operating leverage, low capital demands, and strong free cash flow generation supports a high dividend payout ratio.

Magellan has unveiled FuturePay, its long awaited new fund catering to retirees seeking predictable income. Foreshadowed since fiscal 2019, we expect FuturePay to gain share from standard equity income funds and be used alongside annuities. Unlike the glut of equity funds that pay a percentage-based distribution from buying high-yield stocks, FuturePay feeds into Magellan’s Global Equities and Infrastructure strategies, and targets a fixed distribution per unit that’s indexed to inflation. Distributions are currently AUD 0.0203 per unit per month, equating to an annual yield of 4.3%.

Nonetheless, our fair value estimate retreats to AUD 56.50 per share from AUD 57.50, though shares remain undervalued. The earnings we forecast from FuturePay were offset mainly by higher expected future tax rates, and FuturePay cannibalising some flows into Magellan’s core, higher-margin funds. On the former, we note Magellan is an offshore banking unit, or OBU, enjoying low tax rates– currently 22.2%. The government’s proposed removal of the OBU regime will likely see it pay taxes closer to the corporate tax rate of 30% starting fiscal 2024.

FuturePay is the latest endeavour by Magellan to exploit underserved niches–here the retirement income market– which plays to its brand strength. We forecast FuturePay to capture 1% of the funds moving from the super to pension phase over the next five years–backed by Magellan’s established distribution reach, and reputation among investors, advisers and research houses. This is 75% less than what we project for annuity provider Challenger.

The proposition to investors is certainty in income stream. For advisers, this alleviates the hard work in ensuring a client has sufficient liquidity, especially in falling markets, which may compensate for having to go through more stringent best interest duty hurdles. For FuturePay, it does not have to pay out as much in distributions in rising markets, and can better top up its support trust. The support trust serves as a piggybank to support Future Pay’s monthly income payments in falling markets. FuturePay can also borrow funds from Magellan to meet its income payment obligations.

FuturePay will dampen Challenger’s annuity sales, or qualify as a retirement income product though. There will always be a need for assets with defensive asset allocation, such as annuities, that mitigate longevity risks. FuturePay does not guarantee income or capital, nor does it maximise social security benefits. Entry and exit fees, forgone contributions into the support trust, and the lack of ratings / platform presence are likely to limit its adoption in the near-term. Though, this will likely unravel in time as Magellan ramps up its distribution and advisers get more accustomed to the product.

Magellan’s recent growth initiatives–including FuturePay, which will see it deploy AUD 50 million into Future Pay’s support trust–suggest it is becoming more capitalintensive, with returns on capital forecast to average 57% over the next five years, versus 71% historically. Regardless, this is sensible capital allocation to defend and reinforce its competitive position.

Bulls Say

Magellan has built a strong intangible brand, supported by strong performance, which it can leverage to hold on to client funds, attract new money and charge premium fees.
Due to structural market trends and product expansion initiatives, the prospects for organic FUM growth is strong, notably from investors seeking to diversify exposure to international equities or gain a steady retirement income stream.
Aside domestic tailwinds from superannuation, Magellan’s distribution relationships in the much larger offshore markets of the U.K. and the U.S. should support growth.

Bears Say

The majority of Magellan’s earnings come from a few large funds, meaning it has a high reliance on key investment personnel and the performance of its main funds. Should key people leave, or its main funds underperform for a sustained period, outflows could be material.
There is increasing competition from other active international equity managers and new international equity funds from incumbents.
The firm faces fee pressure from the increasing popularity of lower-cost alternatives, such as index type products and ETFs.

Source:Morningstar

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.