There was an article in the weekend papers [1] that looked at the short position that we disclosed in Platinum Asset Management last month. Unlike a lot of managers, Morphic discloses its short positions by name if these stocks are in our top ten holdings. This can often make engaging with management difficult, but as a firm we believe in maximising transparency to our investors. When the Platinum short position was disclosed, the Australian Financial Review reached out for comment and we provided some of our thoughts on the industry.
The irony of being short Platinum, is that we happen to think Kerr Neilson is a brilliant investor. In some respects, we would never have been able to launch a global fund out of Australia, had he not pioneered the acceptance of running a global fund from Sydney. Furthermore, his unconstrained approach to investing – one that uses the ability to short and go to cash – to manage investments for his investors is one that we believe in and use.
But we are not in the business of rating fund managers. We are in the business of analysing investments and Kerr’s business finds itself at the mercy of three trends, of which he has limited control: falling industry wide fees; rising passive investment share; and a breakdown between manufacturing and sales relationships.
Our most recent perspectives series explained to investors at length the issues facing the industry and our thoughts on how the industry has to adapt to these challenges from passive, so we won’t discuss the passive switch here. It is often said in the media that manager fees are too high. That may well be the case, but the direction is unequivocal: see Figure 1 below.
USA based funds, basis points
Source: ICI, Bloomberg
Another effect that has arrived in the last few years is the collapsing of the attention span of investors. Figure 2 shows (for the USA) the level of “churn” inside funds.
Source: ICI
This means investors are staying for shorter durations with their managers and it means the sales staff has to work harder to continuously find new investors to offset the ones that are leaving. It matters because most people focus on net inflows or outflows to a fund. What really matters, it turns out, is gross flows (inflows+outflows).
It gets worse: those investors who churn used to just move internally. In Platinum’s case it might be switching from their International Brands fund to, say the Japan fund. Nowadays, investors leave the manager altogether.
Source: ICI
To be clear, if it wasn’t already, Platinum is just one of the stocks we are short in the sector. Together these represent about 5% of our Fund.
But returning to Platinum, the title of the blog alluded to why. “Wrong Time” is a reference to the same problem all managers face – being in this sector. “Wrong place” referred to the fact that the business has consistently allocated funds to regions that have underperformed, resulting in pressure from investors on redemptions. But this isn’t a unique problem – many managers underperform. What is unique is they have allocated so few resources to sales. Figure 4 shows the ratio of sales staff to investment team for a number of firms. Clearly Platinum has a different approach to this role to others.
Source: Company information, team research
Secondly, Platinum is unique in how low its cost to income ratio is. Platinum spends less on staff salaries (as a percentage on investment income) than any other listed fund manager we can find. Why does this matter? Because one avenue to survive is to cut costs, but this business is already run extremely well. This may have served prior shareholders, but it leaves few options for future shareholders.
Source: Company reports
Finally, there is a view that performance drives flows. We have found this is only loosely the case. What we mean is not that there isn’t a relationship, rather that it isn’t particularly tight.
But there is one thing that drives flows unequivocally: ratings. These are the “stamps of approval” issued by ratings firms so that financial advisers can recommend them to their clients. And when we analyze Morningstar data, there is clearly a relationship (Figure 6).
Source: 2015, Morningstar, Team analysis
So when we return to Platinum an interesting picture emerges: it is still rated as Four Stars by Morningstar but this is likely to drop to three (and eventually to two) stars in the foreseeable future. It is because of how the Morningstar ratings methodology works – the current rating is influenced by a Five Star 10 year track record, which accounts for 50% of the total rating (see Figure 7) with 3- and 5-year ratings accounting for the other 50%. As time passes, the 10 year rating will begin to “roll off”, and the more recent Two Star periods will become more important.
Source: Morningstar
We have no insights on where Morningstar or any of the other ratings houses are going in their thinking, but there is no room to move upwards, with a clear risk the next move is downwards.
The stock has fallen heavily after the recent results as investors came to the same conclusions as us. The company outlined how it was planning on spending more on sales staff for example and also paid some “exceptional” bonuses. We have reduced our short position for now as near term the stock is pricing these issues more appropriately in our opinion.
[1] Followed by another article here.
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