Record — Explaining strategy and growth

Record introduced a new strategy following the appointment of Leslie Hill as CEO in February 2020 and set out specific medium-term financial targets in June 2022. Before giving details of both strategy and targets it is useful to provide some historical context to show how the group had previously adapted to changing market circumstances and opportunities but prior to 2020 had run into a period of stability rather than growth.

Record was established by Chairman Neil Record in 1983 and from then until 2002 the group’s main activity was currency hedging, with the client base shifting from commercial companies to institutional investors during that period. From 2001 Record developed currency for absolute return products, most notably a forward rate bias strategy, and assets under management equivalent2 (AUME) in this segment grew rapidly in the years to FY08, the financial year in which Record was listed on the London Stock Exchange. In FY08 currency for return strategies accounted for 91% of total revenue and performance fees (mainly earned on currency for return mandates) for 33% of the total.

Market volatility and unprecedented central bank responses to the global financial crisis from 2007 adversely affected the performance of the currency for return strategies and the accompanying fund outflows meant that between FY08 and FY12 AUME in the segment fell from $29.0bn to $1.8bn. In this challenging period, AUME for passive hedging was broadly stable while dynamic hedging AUME rose, but the reduction in the higher fee-rate currency for return segment and absence of performance fees meant that revenues fell sharply (from £66.2m in FY08 to £20.5m in FY12).

Exhibit 1 shows that, reflecting the group’s expertise, the stickiness of long-term institutional clients and refocused marketing, Record succeeded in building AUME again between FY12 and FY17, primarily in passive hedging. The average fee margin continued to trend down, reflecting the changing product mix and a competitive environment. Then, between FY17 and FY20 there was a period of stability, with limited net change in AUME and average fee rate and range-bound revenue and profit (see Exhibits 1 and 2). This was the background to the board’s decision to adopt a new strategy with an emphasis on growth in early 2020.

The group’s strategy has three elements: diversification, modernisation and succession.

To further diversification, the group is developing new products in partnership with clients, including products outside Record’s traditional currency services remit. By virtue of its established products Record has a track record as a derivatives manager, existing administrative and technology infrastructure and a client base that can attract partners that bring their own expertise and an interest in launching a product to meet their own clients’ needs.

The group structure, previously focused on Record Currency Management (which will remain as the core currency services activity), has been developed to support diversification and growth. Record Asset Management (RAM) was founded in Frankfurt (2020) and received its BaFin licence in August 2022 facilitating sales in the EU and enabling it to operate as an asset manager in its own right. The seven-strong team at RAM has extensive experience in sales, structuring of private and illiquid investments, infrastructure investing and traditional capital-markets solutions. Record Digital was established (in April 2021) as a home for Record’s digital initiatives, with £2m ring-fenced for investment in early-stage funds and direct investments. Finally, a group services company, Record Group Services, provides administrative, technology and other support services to the other subsidiaries, avoiding duplication of spending and accelerating the launch of products and services by applying experience from across the group.

New products already successfully launched include the Record EM Sustainable Finance Fund, developed in partnership with UBS Global Wealth Management, which has a current NAV of c $1bn. There is a range of further products in development. These include products involving supply chain finance, Sharia finance, infrastructure and digital assets. All reflect expressed client interest and are being developed with partners that have expertise in each area. In the capital markets event presentation, further detail was given on these initiatives, with the sales pipeline for RAM showing the potential near-term scale and timing of product launches (Exhibit 3). Notable here is how RAM’s role spans distribution, structuring and asset management with a commensurate increase in share of fees depending on its contribution. Fee rates are likely to extend from the upper end of the range charged for currency services (c 20bp) to c 65bp and a number of these products would be capable of earning performance fees. As an illustration, factoring in an average fee of 30bp would point to additional revenue of c £5m per annum from additional AUM of $2.1bn.

RAM’s partnerships bring a range of expertise, as demonstrated in the pipeline above and the next table, which also demonstrates that it has significant existing assets under management.

Record gave further insights on its digital initiative. The impetus for exploring this area came from enquiries from long-standing clients and investment consultants. Record Digital is headed by Rebecca Venis (chief technology officer at Record) and the decision taken was that the best way of understanding and developing opportunities in this area was through a controlled investment of Record’s own funds. To gain access to opportunities to invest, Record Digital has developed a network of people with experience in this area including Phil Bickerton, CIO of the Denlow Family Office, and Chris Tyrer, head of Fidelity Digital Assets Europe. It has also established partnerships with Darren Dineen, CIO of Dair Capital, and Amir Ben-Gacem, an early-stage venture capital investor with extensive experience in emerging market infrastructure investing.

Record Digital has focused on areas where Record is a potential client or its client base can benefit directly and where there is potential for new business opportunities. Two examples of investments made are Block Scholes which seeks to be the ‘Bloomberg of digital assets’, and Fasanara, where Record has invested in a venture capital fund. Out of the £2m ring-fenced for investment, £1.75m has been allocated and £1.25m has been drawn down. In discussion Record noted that it has assumed that Record Digital makes only a limited contribution to its target for revenue in FY25, so significant positive developments here could be incremental to the target or revenues in subsequent years. The modest scale of investment made by the group also means the exposure to the risks typical of early stage investment are contained.

Since 2020 the group has been undertaking a range of IT update projects to increase efficiency and facilitate the extensive data handling it undertakes; fortunately, cost-effective software is available to meet the group’s requirements and the incremental nature of the projects has reduced the risks involved in such changes and the projects have run on time and to budget. The group now has a sophisticated IT infrastructure using a hybrid cloud and on-premises approach. It employs Microsoft Azure (a scalable cloud computing platform), Microsoft BI (a business intelligence platform enabling connection with data sources and visualisation of data) and Xceptor (a data automation platform facilitating data transformation and complex process automation). While individual projects are of a one-off nature and IT spending levels may vary over time, management regards such investment as a continuing requirement. Given the increase in scalability and scope to offer products that might not otherwise be profitable, the potential for attractive returns appears good.

On talent development, key staff members have become meaningful equity owners and the plan is to roll-out the ownership and option programme further, underpinning the cultural change that is underway to ensure that a relatively mature business is able to adapt to market changes and opportunities.

Confidence in succession planning has built since the adoption of the new strategy in 2020, with changes in executive management over that period including chief investment officer (Dmitri Tikhonov), chief technology officer (Rebecca Venis), global head of sales (Dr Jan Hendrik Witte) and other promotions through the organisation to unlock talent and position the group for longer-term progress. Chief Executive Leslie Hill has indicated that she would wish to stay in position to ‘a little beyond’ the end of the group’s three-year plan to FY25. This points to continuity of management over an important phase of the group’s development.

In March the group announced that, non-executive chairman and founder, Neil Record, is to retire from his role and the board at the end of the AGM in July. He indicates that he intends to remain a major shareholder (holding June 2022 just over 28%). David Morrison has been appointed as chair elect, joining the board as a non-executive director 1 March 2023 and taking the chair following Neil Record’s retirement. Currently chairman of CCP (AIM-listed technology-driven assistance group), David has spent the majority of his career in private equity and has had roles as director or chairman at several private and public companies. Between 2009 and 2018 he served as a non-executive director at Record (including as senior independent director 2016–18) so will bring knowledge of the group in addition to his experience in providing board leadership at other companies.

To make clear the board’s confidence in the outlook for the group and the growth potential it sees, a medium-term plan with a revenue target of over £60m in FY25 was set out. The capital markets event gave additional detail on the pipeline of new products and partnerships that are expected to contribute to meeting this goal. The target was set following 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. Performance fees are not included in the target. The group has seen growth in its existing AUME since 2020, including the addition of a c $8bn dynamic hedging mandate in September 2020, and further mandate wins are targeted with marketing in the EU, for example, facilitated by the licencing of the Frankfurt office. 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. Reflecting the cash-generative nature of the business and strength of the balance sheet, the policy is to pay out ordinary dividends of between 70% and 90% of earnings per share with excess earnings available for special dividends subject to capital requirements.

Exhibit 5 sets out headline changes in our estimates. These reflect the Q323 update including new AUME figures (6.4% increase to $86bn), the crystallisation of £3m in performance fees in the quarter and currency movements. We include performance fees earned in 9M23 (£5.8m) for FY23 and £1.5m for FY24, reflecting the more favourable environment for the enhanced passive hedging service but assuming that the exceptional level of performance seen in the current year is not repeated.

The dividend estimates shown exclude special dividends. Based on our FY23 and FY24 basic earnings estimates and assuming a near 100% payout, we pencil in special payments of 2.50p and 2.10p, respectively, giving total dividends of 6.60p and 6.30p. The reduction in FY24 reflects a lower performance fee assumption following the exceptional level seen in FY23 and the increase in the UK corporation tax rate from 19% to 25% resulting in lower earnings.

Finally, while we have yet to include a forecast for FY25, as in previous notes, it is interesting to consider a scenario that could generate the over £60m revenue and 40% operating margin the group aims to achieve. For this illustration we have excluded any contribution from performance fees, in line with the target set by the group. Starting with AUME/AUM, we envisage most of the growth required falling within the currency for return category but also allow for additional inflows in multi-product and dynamic hedging. Our scenario assumes average AUME of c $95bn compared with estimates of $82.5bn and $89.6bn for FY23 and FY24, respectively. We allow for an increase in the currency for return and multi-product fee rates at 29bp and 20bp respectively (compared with 21.7bp and 18.4bp assumed for FY24, for example) both reflecting an increased contribution from new higher-margin products. As a result the overall group average fee rate in the scenario rises to 7.5bp (compared with 5.7bp and 6.1bp respectively in our FY23 and FY24 estimates). This gives revenue just above £60m. On costs we allow for a 14% 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 £24.3m and diluted EPS of 9.3p.

Exhibit 6 shows an updated version of our comparative valuation table, with a selection of quoted UK fund managers. Record trades at a premium to the average calendarised P/E (2023) and EV/EBITDA (2022) multiples for the comparators, although within the range of multiples. Delivery of growth in line with the group’s three-year plan would bring the final year multiple down to c 10x. On our estimates, Record’s prospective yields (including special dividend) would be 7.0% and 6.7% for FY23 and FY24 and, on our FY25 scenario, c 10%.

For reference we include our compilation of information provided by Record on AUME, fee income, clients and asset class exposure (Exhibit 7). This includes our calculations of estimated average fee rates by strategy and hedging fee exposure by underlying asset class. Apart from updating the AUME figures for Q323, in most cases the most recent figures are for H123 (to end September 2022). We highlight several points: