Pinnacle Investment earnings: Resilience evident amid challenging markets
As Pinnacle bucks the negative trend in asset management are the shares attractive?
Mentioned: Pinnacle Investment Management Group Ltd (PNI)
Narrow-moat Pinnacle’s (ASX: PNI) net profit aftertax for the first half of fiscal 2024 was broadly flat from the previous corresponding period and was as expected. The underlying drivers surprised us, though.
Affiliate profits grew 30% from the PCP, with better-than-expected net inflows and fee margins resulting in strong revenue. However, elevated growth expenses exceeded our forecasts, with affiliate pretax profit margins contracting to 41% from 44% in the PCP.
Despite temporary margin challenges, we still expect improvements at the affiliate level as revenue outstrips costs—supported by net flows and higher fee margins. Pinnacle’s countercyclical growth investments—while other active managers embark on defensive measures like cost-outs in response to market volatility—helped attract new flows and diversify its revenue streams.
We continue to expect this trend to persist and retain our fair value estimate at AUD 11 per share. Shares have rerated toward our intrinsic assessment and are now fairly valued.
We expect Pinnacle to resist share losses to low-cost investments and draw net flows from underperforming active peers. Its diverse product range and distribution platform attracted strong net inflows from retail and international investors in the first half, offsetting redemptions from local institutional investors. Net inflows into the private market and alternative strategies compensated for subdued flows into equities funds.
These traits stand out, considering the broader industry trend of net outflows. Strong investment performance, with 81% of strategies outperforming benchmarks over five years, and competitive fees, lower than around 67% of comparable peers, augur well for future business wins.
An inflection point in margins is also underway: first, as boutiques scale up and become profitable; second, through a mix shift toward higher-margin funds under management; and third, through more performance fees that can complement base fee revenue.
Pinnacle Investment Management provides seed and working capital, marketing and distribution services, business support and responsible entity services to a network of boutique managers--which it terms as "affiliates." Apart from charging fees for its services, Pinnacle also earns a share of profits from its affiliates via holding equity interests in them. As of December 2023, Pinnacle has 15 affiliates under its network with around AUD 100 billion in funds under management ("FUM").
Pinnacle typically caters to smaller-scale boutiques that lack the capital, investment infrastructure, and distribution capabilities of larger firms. Affiliates get to access new money from a growing network of investors (including retail and international clients), receive support on product enhancements (for example, help to create active ETFs, offshore vehicles like UCITS, or performance fee-based funds) and outsource back-office tasks.
The firm is also actively diversifying its asset class offerings and client base. Pinnacle is seeking to work with boutiques that manage non-traditional, in-demand strategies such as private capital, absolute returns, credit and ESG. Its client cohort is also expanding, with the proportion of revenue contribution from super and pension funds generally falling with time.
Early-stage affiliates are typically put to invest for institutional investors, before they build a credible track record and are ready to accept retail money. More established affiliates may skip the development stage and sell to a wider audience from the start.
The outlook for earnings is positive as Pinnacle is essentially an incubator for growth. Inflows from new clients, product enhancements, and boutique additions all present opportunities for earnings upside.
We see the appeal in Pinnacle’s business proposition. Amid an increasingly competitive funds management landscape, scale, bargaining power and resourcing depth are key success factors. Affiliates which are backed by Pinnacle are free from administrative burden and can focus on managing money, thereby having greater potential to achieve better returns. Affiliate managers continue to own equity in their own businesses, ensuring alignment with clients.
Pinnacle possesses a narrow economic moat based on the intangible asset of its brand and switching costs. These sources of competitive advantage help provide stability in, and grow funds under management across various market conditions.
Reflecting Pinnacle’s moat sources, affiliate funds under management ("FUM") grew strongly to AUD 100 billion as of December 2023, from AUD 38 billion in June 2018. Affiliate numbers stood at 15 in December 2023, from seven in June 2016. Moreover, net outflows have been infrequent.
Affiliate FUM fell 7.5% over the five months to May 31, 2020 amid the coronavirus selloff, considerably less than key equity indexes (such as the S&P/ASX 300 and MSCI World which fell 13.8% and 9.9%, respectively). Similarly, during the volatility-stricken fiscal 2022, affiliate FUM fell by 6%, less than the S&P/ASX 300 and MSCI World, which each lost 10.4% and 17.1%.
The aspects of Pinnacle’s intangibles are twofold--to investors and asset managers. To investors (notably institutional and intermediary clients), it is a "go-to" destination for high-performing boutiques that have optimal capacity to deliver outperformance. The latter can be challenging for large asset managers to achieve as their investment universe is narrower. Affiliates are gaining popularity among the public, too, as Pinnacle builds out its retail distribution. Retail money accounts for 26% of FUM as of December 2023, from 8% in June 2013.
Pinnacle has a remarkable record of picking the right asset managers to back. About 81% of affiliate strategies and products (with a record exceeding five years) have outperformed benchmarks over the five years to Dec. 30, 2023. Select strategies of Hyperion, Solaris, Resolution, Antipodes, and Firetrail, which collectively manage 51% of FUM, are assigned medallists by Morningstar Manager Research. Affiliate fee rates are reasonably below comparable peers.
On the other hand, Pinnacle is the first point of call for asset managers who seek a growth partner. Execution on helping managers get up to scale has been superior to peers like Fidante and Bennelong. This manifests in the industrywide regard for Pinnacle, which saw it being recognized as the best distributor of the year by Zenith for four consecutive years starting 2016 to 2019. Reporting standards, access to investment specialists, client education and communication of manager strategies are industry leading. Asset managers who partner with Pinnacle remain majority owners of their businesses, incentivizing outperformance.
Pinnacle’s switching costs also extend to both investors and asset managers. Investors are sold products across boutiques and asset classes. This follows a deliberate strategy to diversify its affiliates, asset classes, and product structure--So it can provide investors optionality, upsell products, mitigate downside from redemptions, and minimize negative contagion if any one boutique underperforms. The proportion of Australian equities FUM has fallen to 41% in December 2023--from 67% in June 2016--while exposure to in-demand asset classes such as global equities, real assets, and credit is increasing. FUM invested in private markets (hence hard to be replicated by ETFs) is steadily growing to 16% of FUM. Additionally, product enhancements such as: (1) introducing performance fee-based strategies; or (2) rolling out active ETFs and managed accounts also help it cater to evolving investor needs.
Downside risks from redemptions will progressively reduce as Pinnacle grows in scale and diversifies its client base. Industry super, public pension and corporate pension clients contributed 30% of revenue as of December 2021, versus 42% in June 2016, while revenue from stickier retail money increased to 47% from 27% over the same period.
We think affiliates stand to lose more than they gain if they walk away from Pinnacle. Immediate obstacles include the loss of seed capital and distribution capabilities. On the latter: Pinnacle’s extensive distribution relationships span across client cohorts and geographies, and its sales staff are armed with a broad product suite to entice investors and sell. Accordingly, it can often source money for boutiques more efficiently, versus a boutique going it alone.
Importantly, Pinnacle remains in a position of power even if affiliates were to leave, as it will continue holding equity interests in them. This means Pinnacle can still earn a share of their profits, or demand a premium for its stake to be bought over. Affiliate concentration is reducing with the top-five affiliates currently making up around two thirds of FUM, from 98% in June 2016.