Magellan on track to crack $150bn, but analysts wary

A reputation for outperformance, strong distributional relationships and low interest rates have investors pouring their funds into Hamish Douglass's Magellan, leading to a profit surge and higher dividend, says Morningstar equity analyst Chanaka Gunasekera.

Magellan Financial Group (ASX: MFG) booked a 23 per cent increase in underlying net profit after tax to $216.8 million, fuelled by a rapid increase in funds under management.

Strong market performance over the half and consistent inflows–partly driven by the launch of the Magellan High Conviction Trust–drove funds under management to close around $98 billion at the end of December 2019, up 12 per cent from 30 June 2019.

This has prompted Gunasekera to increase his fair value for the global equities fund giant to $52 per share, up from $47.

"A series of tailwinds are propelling Magellan’s FUM growth, notably: an enviable reputation of outperformance; strong distributional relationships, a favourable trilogy of low inflation, low interest rates, and low growth globally," he says.

"This is leading to investor risk aversion and a chase for growth and yield which is increasing the demand for managers such as Magellan with a strong focus and history of protecting against downside risks and strong dividend growth."

Magellan's gold-rated flagship fund – Magellan Global – delivered returns 2.21 per cent above the MSCI World Ex Australia in 2019, returning 28.05 per cent. The fund similarly outperformed in 2018, delivering returns 8.3 per cent above the index.

Douglass has placed a major bet on Microsoft Corp, with over 6 per cent of the portfolio weighted to the US software giant. Other top holdings include Google parent company Alphabet, social media juggernaut Facebook, coffeehouse Starbucks and Chinese e-commerce titan Alibaba.

Growth of $10,00, 10 Yr, Magellan Global Fund

YTD Fund as of Jan 31, 2020 | Category: Equity World Large Blend as of Jan 31, 2020 | Index: MSCI World Ex Australia NR AUD as of Jan 31, 2020. Source: Morningstar Premium

Gunasekera now expects funds under management to grow to $149 billion by fiscal-2024, up from a previous forecast of $142 billion.

Higher expected earnings have also led to an increase in Gunasekera's fiscal 2020 dividend forecast to $2.15 per share.

Euphoria priced in

But Gunasekera says it isn't necessarily a good thing to own this top performing manager. Magellan screens as expensive, closing Monday at a 40 per cent premium to fair value and a price to earnings ratio of over 30 – close to double the average of competitors Platinum, Pendal and Janus Henderson.

Gunasekera says Magellan - like all active fund managers - faces the structural headwind from the growth of passive investments, such as index funds and ETFs, which generally have much lower fees.

"Pure active managers with a long history of outperformance and deep client relationships, such as Magellan are better placed than most to address this headwind,” he says “However, Magellan is unlikely to be completely immune in the long run.”

Related article: A fireside chat with Magellan’s Hamish Douglass

Following the recent listing of the Magellan High Conviction Trust (ASX: MHH), Gunasekera expects Magellan to continue to launch new investment funds, particularly directed at the self-directed investor. Institutional clients, he says, are nearing capacity, and Magellan already has high penetration in the retail adviser channel.

"Retail money is generally higher margin and stickier, so we weren't surprised with the decision to list the Airlie Australian Share Fund on the ASX [in the second half]."

Management flagged that the Magellan Retirement Income Fund will make its debut in the second half of 2020, aimed at servicing clients in their retirement phase of superannuation.

“There’s more money in retirement phase than in the accumulation phase," Douglass told the crowd at the Morningstar Investment Conference in May last year, arguing that the space had been neglected for three decades.

Read Gunasekera’s full report:  Magellan continues to defy valuations but much of the euphoria appears already priced in

Morningstar has compiled a handy list of more than 150 companies under coverage that will release earnings results during February Reporting Season.