You don’t often hear a chief executive say that analysts are too bullish on his company’s prospects.
So my interest was piqued when I saw the boss of Aberdeen Asset Management (LSE: ADN), Martin Gilbert, do just that on Friday.
Gilbert reckons that the City’s hopes for Aberdeen and the rest of the asset management industry are simply out of step with reality.
In effect, he’s saying that share prices in the sector are too high.
It’s a refreshingly honest take. But in this case, I think he’s wrong. There are some good opportunities in this sector – you just need to know where to look.
Money managers have over-promised and under-delivered
Gilbert gave his views on the money management business on Bloomberg at the end of last week.
“We have got into a situation where the industry has over-promised and under-delivered… Analysts have been a bit too bullish on the sector. At one stage, we [at Aberdeen] had 19 buy ratings and three holds – you can only go one way from there.”
Gilbert’s view is sensible, no doubt about it. We’re five years into a bull market. It’s not the longest ever, but it’s beyond the average bull market length. So it would be no great surprise if the stock market fell significantly at some point over the next couple of years.
If that happened, the value of the assets that Aberdeen manages in various funds would fall. And as a result, Aberdeen’s fee income – and therefore its profits – would fall too.
Aberdeen has also been hit by the poor performance of emerging markets over the last year. Emerging-market funds are the core of Aberdeen’s business, so the company inevitably suffers when sentiment turns against the likes of China and India.
Indeed, Aberdeen lost a mandate to look after assets worth £4bn for a group of Asian investors earlier this year. The strength of the pound has also hurt the company.
What’s more, some of the long-term trends for the fund management sector are also negative. Thanks to regulatory changes, fund investors are now better informed about where their money is going. No longer do investors just pay one annual charge for a fund investment. Instead, they pay separate fees to the fund manager and the platform provider, such as Hargreaves Lansdown (LSE: HL).
This greater level of transparency is pressing Aberdeen and its peers to cut charges. And increased competition could drive charges down further. As Gilbert put it: “The fund management-sector has been very easy… It’s a high margin business. It does tend to bring in the competition.”
On top of that, more and more investors are waking up to the advantages of passive funds over the more expensive actively-managed funds. (A passive fund just tracks a particular stock market index and normally buys all the shares in that index. Active funds employ expensive fund managers to pick their favourite shares, in the hope of beating the market.)
Many large fund management companies don’t offer any passive funds. Even where they do, they’re inevitably less profitable, given the lower charges that come with them.
It’s not all bad news – there are a few good stocks in this sector
Given this background, I agree that some fund management companies are definitely over-valued. Henderson Group (LSE: HGG) is one example. About a fifth of its income comes from performance-related fees. These charges will be especially vulnerable if we see a serious stock market correction.
But there are some reasons to be positive about other firms in the sector.
For starters, I think there’s a growing awareness that we all need to save harder. A big chunk of those savings will go into the stock market via investment funds. The new £15,000 annual limit for Individual Savings Account (Isa) investing should also help.
I also think that, despite all the bad news, the valuations for some fund management groups have probably fallen too far. Perhaps surprisingly, Aberdeen is one of the best examples. The share price is down 15% this year, and the price/earnings ratio is now just 13 as a result. That’s not too bad at all.
What’s more, Aberdeen bought Scottish Widows Investment Partnership (SWIP) earlier this year. SWIP has a decent passive business, so Aberdeen is now a more diversified business and less reliant on emerging markets.
But fund management companies aren’t the only way to play the likely long-term trend of increased stock market investment by private individuals. You can also invest in the investment platforms that enable you to buy shares and funds cheaply over the web.
The best known is Hargreaves Lansdown, and it’s been fabulously successful in recent years. However, I’m not tempted to buy, because it just looks too expensive, and greater competition may force Hargreaves to cut its prices (and margins), before too long.
However, one other stock has caught my eye in this area. It’s Charles Stanley (LSE: CAY). Historically, the company is a traditional stockbroker. But it’s now sensibly moving to where the growth is, and has launched Charles Stanley Direct, a rival to Hargreaves Lansdown. This new(ish) platform looks good, and I suspect Charles Stanley can be a successful player here. The rest of Charles Stanley’s business seems to be doing reasonably well, so at 343p, the company does look tempting.
So, overall, I think that Gilbert was a little harsh on his sector – perhaps reflecting the drop in his company’s share price in the past year. Sure, there are no screaming bargains here, and there are issues to worry about, but both Aberdeen and Charles Stanley should prove to be decent investments in the long run.
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