Platinum Asset: Interim result 2012

Fund management companies have some of the simplest accounts: they have a pile of money on which they earn a percentage fee, and they have salaries, marketing, rent and some admin fees to pay. If you take one from the other, you’re left with a profit (and you probably won’t be far from the free cash flow).

In Platinum Asset Management’s interim result, the pile of money averaged $15.2bn (down 6.2% from an average of $16.2bn in the prior period), the fees came to $102.7m (down 6.6% from $110.0m) the costs were $19.4m (down 4% from $20.2m).

That left an operating profit of $83.4m (down 7.2% from $89.9m). After some interest and tax, net profit fell 7.0% to $62.4m and earnings per share fell the same amount, to 11.2 cents. An unchanged fully franked interim dividend of 8 cents was declared, payable on 18 March.

Jumpy markets

It all seems so simple. Except it’s not, because the key factor – the future development of the pile of money – is so hard to pin down. Markets can be jumpy, performance can be fleeting and investors can be fickle. So much so that guessing the level of funds under management even a few years’ hence is nigh impossible – let alone the long-term projections necessary to make a reasonable stab at valuation.

And yet fund managers have wonderful business qualities, converting almost all their profit into free cash and with favourable long-term industry dynamics from compulsory superannuation. We’d love to find some good ones to buy.

So what are the qualities we should look for? First, we need to find a fund manager with an investment approach that should be successful over the long term. For us that means a skillfully applied value investing approach (Platinum scores a resounding tick on this measure). Second, we need it to have a reasonable handle on costs (again, a big tick given the operating margin of 81% in the half).

The hard sell

Our third criteria is an ability to sell the message and thereby pull in the funds under management. This is where Platinum has fallen down over the past few years. It absolutely smashed the market in the aftermath of the global financial crisis, building on years of outperformance, but somehow funds under management never saw the benefit. No doubt its refusal to pay commissions to financial advisers is part of the story, but this problem will be reduced when such commissions are banned from July this year.

There’s an upside to not pushing the story too hard, though, because the harder you sell, the more you pull in marginal investors, and they’re the first to leave when times get tough. By contrast, if investors come directly to you, for your investment approach and long-term performance, then they’re likely to cut you more slack.

Platinum’s funds under management peaked at $22.2 billion back in February 2007 (shortly before its flotation in May that year, which is further demonstration of Kerr Neilsen’s investment nous). They fell to $13.6bn during the GFC, but that was mostly down to market performance, and they have since edged back to $17.3bn. There has been no rush for the exits.

Buying when others are fearful

Notice that underlying market performance is not on our list of criteria. We’re very confident of the sharemarket’s ability to capture the economy’s wealth generation over the long term, but we don’t think its movements can be predicted in the short term. So the answer here is just to take the status quo and add an appropriate long-term growth rate each year. Right now, that’s probably only about 5% per year (to give total returns in the high single digits after dividends).

For the broader market, however, short-term market performance most certainly is a swing factor – and that's what provides the opportunity: when markets have been going up, as they have been recently, investors appear to factor in a continuation of that – as they do when markets have been falling.

Putting it all together, our approach is to find fund managers with the right skills and investing approach, a handle on costs and preferably an ability to get their message across – then buy them when others are most fearful.

We got this wrong when we recommended Platinum soon after its float, on 23 May 07 (Long Term Buy – $7.90), when others were not fearful in the least. But we continued to back the company during its darkest hours (see FUM’s down for fund managers on 24 Jul 08 (Buy – $2.94) for example) so hopefully members had the opportunity to average down.

More recently we’ve moved back to Hold and, with the stock up 5% since 5 Feb 13 (Hold – $5.05) that continues to the be the right recommendation, although we're raising our Sell price further to reflect the improved status quo (FUM has risen further this year and Platinum’s fund performance has also improved). We’re hopeful of further opportunities to buy this excellent company, but markets will probably need to have a wobble first. HOLD.

Note: Our model Growth and Income portfolios own shares in Platinum Asset Management.