Record — Changes taking effect

We have updated our compilation of information Record provides on AUME, fee income, clients and asset class exposure (Exhibit 1). This includes our calculations of estimated average fee rates by strategy and hedging fee exposure by underlying asset class.

We highlight several points:

As announced in the April Q422 trading update, Record’s AUME increased by $3bn in FY22 (+3.7% and 8.6% in sterling terms). As shown in Exhibit 2, this mainly reflected net AUME inflows ($2.4bn), with positive underlying market moves since March 2021 and exchange rate and scaling moves adding $0.6bn.

Using reported quarter-end figures we calculate that average AUME for the group increased by 22% and 17% in dollar and sterling terms, respectively. The average level of AUME in FY22 benefited from the full inclusion of a large dynamic hedging mandate announced in September 2020 that was included in the $6.6bn inflow seen in that segment in FY21.

The profit and loss (P&L) account for FY22 is set out in Exhibit 3. We comment on key areas below, with comparisons versus FY21 unless stated.

On product investment performance, Record reports that central bank tightening and increased interest rate volatility has enabled the enhanced passive hedging product to add value; over FY22 a representative account recorded a positive return of 13bp relative to a fixed-tenor benchmark and since inception there was a positive return of 9bp per year. For comparison, the average fee rate in passive hedging is under 3bp. Episodic strength in the US dollar created the conditions for dynamic hedging to add value for US investors. For a representative account the value added in FY22 was 60bp and the since-inception return was +46bp per year.

Within currency for return products, the Record EM Sustainable Finance Fund (US dollar share class) had a negative return since inception (28 June 2021, -0.94%) but significantly outperformed relevant indices such as the JP Morgan GBI-EM Global Diversified Index (-12.07%). Finally, the multi-strategy product generated a positive return of 0.58% and a since-inception return of 0.83%, with volatility of 3.08% per year.

Group management make clear it is very pleased with the progress of the strategy adopted following the appointment of Leslie Hill as chief executive two years ago. The three strands – diversification, modernisation and succession – are all advancing and starting to bear fruit as evidenced within the FY22 results and commentary.

On diversification, the launch of the Record EM Sustainable Fund and a new Luxembourg-based municipal bond fund are illustrations of the group’s new emphasis of meeting clients’ needs and working in partnerships (with UBS Global Wealth Management for the former and Universal Investment and VTeam for the latter). This approach helps to gain early traction with investors, reduces launch costs and brings in third-party expertise to broaden Record’s potential reach while still earning higher fee-margins as an asset manager than in its traditional overlay hedging products. Looking ahead, the group has devoted considerable effort to develop its capabilities in sustainable investment and is working on further impact and sustainable investment initiatives. Products involving supply-chain finance, syndicated loans and Sharia compliant finance are in the pipeline. Recent approval of the application for a licence from BaFin for the German subsidiary will facilitate development of a European asset management business, as will creating a suite of Luxembourg funds allowing Record to offer more to its partners and clients.

Modernisation of IT systems is enabling more effective delivery of Record’s established areas of expertise in currency and derivatives and should contribute to scalability and operational gearing as the group moves towards its three-year FY25 targets. As noted earlier, IT development and hence spending are expected to remain a feature at the group.

Succession. Development and retention of younger members of the team to take over management responsibility in due course has been a prominent theme. This has included promotions and hence financial reward, but also changes such as the opening of a London office, continuation of flexible working, mentoring programmes, development of sustainability capabilities and diversity and inclusion policies. Staff retention fell markedly in FY22 at 74% compared with 90% in FY21. However, this was a sign of the evolution taking place in the group with the need to change some management groups in line with the modernisation of systems and client-led approach to product development. This has been carefully managed and some senior staff have now taken alternative or advisory roles, retaining their expertise within the group.

To make clear the board’s confidence in the outlook for the group and the growth potential it sees, a three-year plan with a revenue target of over £60m in FY25 has been set out. While the detail behind this aspiration has not been given, it reflects a bottom-up assessment of potential for growth in each product area with the promising development of new, higher fee-margin products a key element of the expected growth. In addition to the revenue target, Record sees an operating margin of 40% as being achievable in FY25 (subject to the effects of inflation) as higher AUME brings into play the scalability of the modernised systems now in place.

The macroeconomic and geopolitical background for equity and fixed-income markets is challenging and this is likely to have some effect on the progress Record makes over its three-year plan and our forecast period to end-FY24. However, the development of new products and the diversity of clients’ underlying assets provide some mitigation.

Exhibit 4 sets out the headline differences between estimate and outcome for FY22, changes in our FY23 estimate and our newly introduced FY24 estimate. For FY22 the outcome was close to expectation. For FY23, full inclusion of the Record EM Sustainable Finance Fund introduced in Q222 is a contributor to growth. In this case it seems reasonable to allow for further net allocations to the fund and, as previously, we have assumed $0.4bn (and the same for FY24). Similarly, we assume a $1bn inflow into the municipal bond fund in each year although the revenue effects of this are lower given the expected fee rate of c 13bp. These assumptions are indicative with risks in both directions. The changes for FY23 compared with our old forecast arise primarily from updated sterling/US dollar rate and fee-margin assumptions. As usual, our estimates do not include any assumed performance fees so any that are crystallised would represent upside from our figures.

Our dividend estimate shown above excludes special dividends. Based on our FY23 and FY24 basic earnings estimates and assuming a near 100% payout, we pencil in special payments of 1.05p and 1.1p respectively, giving total dividends of 5.45p and 5.65p.

The group figure for net cash and money market instruments managed as cash at the year-end was £17.3m (a comparable own cash figure for FY21 was £16.2m after stripping out the non-controlling interest share of cash held by seed funds). Summarising the cash flows, net operating cash generation was £11.4m while dividends absorbed £6.5m and share buybacks £4.5m: investing activities and other movements added £0.7m giving the £1.1m increase in own cash.

The group capital position remains strong. At the end of FY22 Record had regulatory capital resources of £25.3m compared with a regulatory capital requirement of £5.4m (FY21 £9.4m). The introduction of new products may increase the capital requirement, but the capital position is seen as well able to support the growth envisaged in the three-year plan.

Finally, while we have yet to include a forecast for FY25, it is interesting to consider a scenario that could generate the over £60m revenue and 40% operating margin the group seeks. For this illustration we have excluded any contribution from performance fees. Starting with AUME, we envisage most of the growth required falling within the multi-product category but also allow for additional inflows in currency for return and dynamic hedging. Our scenario assumes average AUME of just over $94bn compared with existing estimates of $85.7bn and $88.5bn for FY23 and FY24, respectively. We allow for a marked increase in multi-product fee rate at 28bp (compared with 18.4bp assumed for FY24, for example) and a smaller increase for currency for return both reflecting the effects of new higher margin products, with fee rates potentially ranging between 20bp and 50bp. The overall group average fee rate is assumed to rise to 7.8bp (compared with 5.9bp and 6.2bp respectively in our FY23 and FY24 estimates). This gives revenue just above £60m. On costs we allow for an 18% increase in total operating expenses compared with our FY24 estimate, reflecting mainly an increase in group profit share but still generating considerable operating leverage and matching the target 40% operating margin. This would give pre-tax profit of c £24m and diluted EPS of just over 9p.

Exhibit 5 shows an updated version of our comparative valuation table, with a selection of quoted UK fund managers. Year-to-date, the comparator asset managers share prices are down 32% on average, while Record shares are 18% lower, potentially a reflection of its lower sensitivity to equity market volatility and the growth it is demonstrating. It trades at a premium to the average calendarised P/E and EV/EBITDA multiples for the comparators, although delivery of growth in line with the group’s three-year plan would bring the final year multiple down to c 7.5x. On our estimates, Record’s prospective yield (including special dividend) would be 8.1% for FY23 and 8.4% for FY24.