Record — AUME at a high, investing in products, services

Founded in 1983 by chairman Neil Record, the company’s main activity is the provision of currency hedging services to clients, including public and private defined benefit pension schemes and other institutional investors. Currency for return, multi-product and related services are the other contributors to revenue.

In H118, passive hedging accounted for 54% of management fees. Passive hedging mandates tend to be sticky and revenues from these clients broadly cover Record’s operating expenditure before variable remuneration and one-off costs related to the tender offer. Record emphasise that passive hedging is far from being a commoditised service with requirements including strong expertise in execution, operational efficiency and ability to customise the offering with related activities such as collateral management. Dynamic hedging also targets systematic reduction of currency risk while seeking to modify the level of hedging to allow clients to gain some benefit from weakness in their own currency. Currency for return strategies aim to exploit stable inefficiencies in currency markets and include a number of strategies such as forward rate bias, emerging market currencies, momentum and value. The multi-product category includes mandates where hedging and return-seeking strategies are combined on a bespoke basis.

We have collated Record’s detailed disclosure analysing AUME and management fee exposure in Exhibit 1.

The first section underlines the predominance of hedging for both AUME and fees despite the relatively low fee rate applied in passive hedging. The client analysis shows that while the number of clients has been stable recently it has increased noticeably since 2013. Reflecting the institutional nature of Record’s market there is quite a high concentration of fees from the top 10 clients (76%). The third section highlights the importance of Switzerland as a market (primarily for hedging services) and the progression of AUME in recent years. Finally, the analysis of exposure of the dynamic and passive hedging mandates to different underlying asset classes shows that, on our estimate, roughly 50% of hedging fees are related to equity assets and 30% to fixed income assets.

Following Record’s Q218 update released in October, which gave details of changes in AUME and commentary highlighting the investment being made in headcount (see note), the first-half results for the period to end September were in line with expectations. Revenue was up 14% while, reflecting increased costs, the operating margin was two points lower at 31% versus 33% in H117. Even so, pre-tax profits increased by 6% while the ordinary dividend per share was raised by 39%. Key points from the figures are summarised below.

An interim dividend of 1.15p was declared compared with 0.825p last year; this will be paid on 22 December. The thinking behind this increase was that the £10m tender offer in July this year resulted in a c 10% reduction in the share capital and the board wished to preserve the total payment with an addition to maintain its progressive dividend policy. The second half payment is expected to match the first half and the board will consider the return of earnings in excess of the ordinary dividend after allowing for increased capital requirements. On our estimates this could allow a special dividend of up to 0.85p giving a total payment of 3.15p for FY18.

The next table shows performance figures for currency for return strategies. This shows mixed performance in H118 with positive performances from emerging markets and currency value more than offset by negative performances in the remaining strategies within the multi-strategy product. Nevertheless, returns since inception remain positive across all strands with the diversified multi-strategy performance in particular offering an interesting track record of positive returns and moderate volatility from a strategy with a low correlation to equity indices.

Following the appointment of new auditors the first half figures were marked by a presentational change relating to seed investments in three funds that are consolidated in the accounts. External investments in these funds are now shown as financial liabilities on the balance sheet rather than a non-controlling interest. Gains and losses attributable to external investors in these funds are no longer included in operating profits and there is no figure on the profit and loss account relating to non-controlling interests. Gains or losses relating to the seed funds previously included within revenue are now shown within the other income or expense line. On restating last year’s figures there is no change in the earnings or equity attributable to ordinary shareholders.

The uncertain global macroeconomic and geopolitical background continue to create a generally favourable backdrop for Record’s conversations with potential hedging clients even when currency volatility remains relatively low (see Exhibit 4).

The company note that although clients and potential clients may acknowledge the value of maintaining a hedge even when there are periods of base currency weakness, the persistence of cash outflows to retain this position while near-term currency gains could have been realised can act as a deterrent in markets such as the US where hedging tends to be viewed more tactically. For the moment therefore the US may prove a less fertile source of mandates while Europe (given euro strength) is more promising.

At the time of the results Record noted that some smaller clients might cease hedging following the introduction of EMIR (European Market Infrastructure Regulation) at the beginning of 2018. This is because of the requirement it brings for the posting and hence management of collateral for deliverable forward foreign exchange contracts, adding to the cost and administration involved. Since then Record has highlighted that these requirements may now be amended before their introduction, but has also confirmed it does not expect the revenue impact to be material in either case.

Under a licencing agreement Record continues to provide WisdomTree Investments with signals used to hedge currency exposures dynamically for WisdomTree’s rules-based indices. This is included within other currency services income (£0.25m H118) and, while not large currently, could with the addition of other clients, become a more significant contributor to revenue.

As shown below there has been very little change in our revenue, profit and EPS estimates following the first half figures. Further details are shown in the financial summary (Exhibit 7). We have increased our ordinary dividend assumptions by 10% following the declaration of a 1.15p interim. There is a marginal increase in our estimated total dividends (now 3.15p and 3.36p for FY18 and FY19 respectively) as the assumed special dividend has been correspondingly reduced to retain earnings cover.

We have updated our comparative table showing the P/E and EBITDA multiples for Record in the context of UK fund managers.

This shows that even though Record shares are up c 50% over the last 12 months they are still trading on multiples below the average for the UK fund managers shown. With a balance sheet that remains strong following the tender offer and a distribution policy that means that earnings are set to be largely distributed there appears to be scope for further re-rating.

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