Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Listed managers down but not out
Many listed managers have been dragged back to earth in the recent spate of market volatility, but Morningstar believes some of the strongest names are oversold – and that they’ll soon mount a recovery.
It’s the classic path from (somewhat) overhyped to (heavily) oversold. The share price of Magellan has fallen some 74 per cent from its highs; Pinnacle and Pendal have lost about half their value; and Platinum remains deep in the doldrums. Other managers – like the brand-new (in Australia) GQG Partners – have also lost their luster. But Morningstar doesn’t believe the bad days will last much longer.
“With such a fertile hunting ground, we think the market is underestimating the key investment strategies of these asset managers, and their ability to deliver positive alpha and attract money. We think the outlook for asset managers is better than what’s currently being priced in,” writes Morningstar equity analyst Shaun Ler.
“Recent market declines suggest future investment returns will likely improve. Their strong fundamentals, such as having solid operating cash flows and relatively low capital intensity support our conviction.”
A badly-battered Magellan is Morningstar’s top turnaround pick; Ler holds that the market is underestimating Magellan’s potential to improve its performance, with attempts to reduce key person risk in the aftermath of Hamish Douglass’ departure and the safe hands of returning co-founder Chris Mackay and alumnus Nikki Thomas giving rise to hopes of a strong recovery. Still, Ler doesn’t anticipate that there will be material alterations to Magellan’s global equity strategy – which has suffered from continued underperformance.
“Granted, Magellan Global’s weak recent performance has taken some shine off the strategy,” Ler writes. “Its underperformance over the three months to February 2022, a period of heightened volatility, also meant it failed to protect from the downside here.”
“We acknowledge Magellan made mistakes, but its investing calibre is not broken. We think the underperformance largely reflects Magellan’s overweight toward technology stocks, which were sharply de-rated amid the double whammy of rising rate expectations and government crackdowns (as with the case in China).”
Ler believes Magellan will average a 15 per cent return per annum for the five years to fiscal 2026 – defying consensus, which is pricing in continual below-index returns – with the global fund’s top 10 holdings expected to grow earnings per share by a 12 per cent compound annual growth rate (CAGR). Ler also doesn’t think that there will be future heavy detractions to performance similar to those that followed the sharp re-rating of many of the technology stocks Magellan own in the face of rising inflation.
“We view this underperformance as a one-off (but damaging) disruption, and do not believe Magellan’s investing acumen has diminished,” Ler writes. “However, we recognise that until Magellan Global outperforms its benchmarks again, ongoing institutional redemptions and CIO Hamish Douglass’ leave of absence could see more redemptions.”
“This is undeserved in our view, as we believe there is no fundamental breakdown in Magellan’s investment process. Note that interim lead manager Chris Mackay also adopts a parallel investing style to Douglass.”
Ler contends that Pinnacle can also continue to gain market share from competitors; its affiliates are “highly competitive” in terms of both performance and fees, with an expanding product suite that can be tailored to different market conditions. Pendal’s strong performance supports future flows, while the substantial undervaluation in Platinum’s portfolios supports “higher future investment returns” – though its contrarian investment style suggests future performance could be patchy.
“We believe Pinnacle, as a holding company of multiple boutiques, has a more resilient business model than standalone boutiques,” Ler writes. “Notably, its relevance across market cycles is something individual boutiques cannot replicate.”
“We think the firm remains in growth phase, and see it growing FUM at an 18 per cent CAGR to AUD 204 billion by fiscal 2026, supported by net inflows at high-single-digit growth rates. The firm’s information ratio of 0.1 (at the group level) alludes to Pinnacle’s tactic to assemble a list of uncorrelated strategies, so it can adjust the mix of its client offerings based on varying market conditions. We estimate 69 per cent of strategies (by number) are in net inflows.”
