Treasury: A tale of two managers

What’s a decent investment record? Two out of three? (not bad, according to Meatloaf). Six out of ten? What about three out of ten?

The fact is Treasury Group, an investor in boutique funds management businesses, has done very well with just three of its 10 investments becoming successful over the past decade. Four have been duds while the remaining three need more time before judgment is passed (although Celeste looks promising). It’s an important lesson: As long as you don’t lose too much on your duds, three from 10 can make you plenty.

RARE is the latest of Treasury’s boutiques to join the trio, which also includes Investors Mutual (IML) and Orion Asset Management. RARE’s strong performance continued over the 2012 financial year, with funds under management (FUM) rising from $4.2bn to $4.6bn over the nine months to 31 March 2012. The problem has been that only two of the three fire at once. IML was the laggard until this year, with FUM having fallen from $6.0bn in 2007 to $2.2bn in 2011.

On 17 Nov 11 (Hold – $3.88) we suggested there was ‘early evidence of a turnaround at Investors Mutual’. That case is now even stronger. IML has won several industry awards but more importantly, inflows have been increasing; the company recently announced it had won an institutional mandate from Russell Investments, taking its FUM back above $3bn.

Institutional money is lower margin than retail but this win is a big step in the right direction. The ongoing erosion of FUM has finally been stemmed and a turnaround now looks underway.

Having nurtured RARE and disciplined IML, how is Treasury’s third child doing? Once the golden-haired boy, Orion has become a difficult teenager with a report card that says ‘must do better’. The performance of its flagship fund was -12.9% in the year to 30 June 2012, much worse than the S&P/ASX 200 index, which produced -6.7%. The fund has now underperformed over one, two, three and five year periods (see Table 1).

This poor record comes at a tricky time. Orion has taken marketing to retail fund holders back in-house but small investors won’t be attracted by such a track record. Orion has also just lost a $500m equities mandate, taking its FUM down to around $4.3bn. Lower margins aren’t the only problem with institutional money; it doesn’t stick around long when performance deteriorates.

As IML’s experience proves, a fund manager’s performance tends towards the cyclical. Orion’s fortunes may well improve although given its importance to Treasury—Orion’s profits were about equal to those of IML in 2011—any deterioration in FUM will hurt. Thankfully, in the 2013 financial year lower FUM at Orion will be offset by higher FUM at IML.

For the 2012 financial year just ended, Treasury recently announced that underlying profit will be between $7.5m-$8.0m (down from $9.7m in 2011). Second half profit will be lower than the $5.2m reported in the first half—see 24 Feb 12 (Hold – $4.09)—due to lower average FUM at IML, Orion and Treasury Asia Asset Management. Reflecting confidence for 2013, however, the final dividend will be held steady at 20 cents, making 34 cents for the year.

Pleasingly, new chief executive Andrew McGill seems to be doing a few things right, trimming costs and employing new staff in the important area of distribution. He has also refused a bonus for the 2012 year.

On 17 Nov 11, we said ‘activity should be expected’, and McGill has recently announced investments in two new boutiques—absolute return manager Evergreen Capital and Asian-based trading firm Octis Asset Management. The prices paid look reasonable and, with a total investment of just $1.6m, they’re hardly bet-the-company deals. Only time will tell whether the effort to nurture these managers is worth it; as we’ve seen, more boutiques fail than succeed.

Treasury’s profitability—and dividends—depends on the underlying profitability of its boutique fund managers. While its long term record at identifying successful boutiques has been pretty good, the risks prevent us from upgrading, despite the stock looking fairly inexpensive on most criteria.

If you’re comfortable with low stock liquidity and are seeking diversified exposure to a market recovery, then Treasury is a reasonable way to play it. We’re less sanguine with the outlook for markets, however, which is why we’re sticking with HOLD.