Record — Showing good growth and on track strategically

We have updated our compilation of information provided by Record 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 October Q223 trading update, total AUME stood at $80.8bn at end-September. This was 2.8% below the end-March level and 3.9% below the end-H122 figure (see Exhibit 2). Net AUME inflows of $8.6bn in H123 (the fourth consecutive half-year period of inflows) included $5.6bn from new client mandates. These inflows were more than offset by market, foreign exchange and other moves totalling $10.9bn in a period of elevated volatility.

Weakness in the pound mean that in sterling terms AUME increased by 14.6% in H123 to £72.3bn. We calculate that average AUME in sterling terms for H123 was 10% above the prior year period and nearly 5% above H222.

The profit and loss (P&L) account for H123 is set out in Exhibit 3. We comment on key areas below, with comparisons versus H122 unless stated.

Turning to product investment performance, Record reports that increased market volatility has provided the backdrop for strong performances by a number of its products. In passive hedging the enhanced passive hedging product added value; during H123 a representative account recorded a positive return of 11bps relative to a fixed-tenor benchmark and since inception there was a positive return of 10bps per year. For comparison, the average fee rate in passive hedging is under 3bps.

Strength in the US dollar created the conditions for dynamic hedging to add substantial value for US investors. For a representative account the value added in H123 was 648bps and the since-inception return was +95bps per year.

Within currency for return products, the EMSF fund (US dollar share class) has seen negative returns reflecting the difficult background for emerging markets during a period of dollar strength. However, it has significantly outperformed relevant indices such as the JP Morgan GBI-EM Global Diversified Index with a return since inception of -3.61% compared with -23.46% for the index. Based on this outperformance, Record sees scope to market this strategy more broadly to attract reallocation within the sector. There is also the potential for increased allocations to the fund itself in due course from within Record’s strategic partner, UBS Wealth Management.

Record reports that it is progressing well in implementing its strategy to accelerate growth in a sustainable way. As a reminder this has three strands: diversification, modernisation and succession.

Diversification is well underway with the EMSF fund and the Municipal Bond fund both launched (though the latter is having limited traction to date because of changes in the market background). There are a range of other initiatives in progress with further details to be given in the group’s capital markets afternoon in February 2023. 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. Record can bring the ability to provide a fund structure, administration and client access (it has a Luxembourg fund platform and has received a BaFin licence in Germany). Management stresses that currency management remains core for the group and that no individual new product will be allowed to become too dominant. This was underlined in relation to digital assets (including a potential crypto fund). Group investment here is to be capped at £2m and care has been taken to select partners (both funds and direct investments) whose track record and governance are seen as appropriate.

As noted earlier, costs have risen in part because of the investment in IT modernisation to increase efficiency in the business, facilitate new products and increase scalability. IT projects are running on time and to budget.

Confidence in succession planning has built following two years of change involving new senior appointments (chief executive, chief investment officer and chief technology officer) and other promotions through the organisation to unlock talent and position the group for longer-term progress. Chief Executive Leslie Hill indicates 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.

The group reiterates the financial targets previously given for the three-year plan: revenue of over £60m for FY25 based on detailed assessment of the product pipeline and an operating margin of c 40%, subject to inflation levels.

As outlined above Record is making good progress in developing its platform and new product initiatives. Meanwhile performance of existing products has been more positive and currency volatility provides a positive environment for conversations with potential clients. At this point the timing and scale of new product launches is uncertain so they are not factored into our forecasts for FY23–24. The capital markets afternoon in February 2023 may provide a framework to make estimates of the impact of the diversification programme. In the meantime, the group’s target revenue for FY25 gives an indication of its aspirations for the impact of growth in new and existing products.

Exhibit 4 sets out headline changes in our estimates. These reflect the strong performance in H123, currency movements, updated fee rates and more conservative estimates for near-term additions to the ESMF fund. We no longer assume inflows to the municipal bond fund although the revenue effect of this is small given the expected fee rate of c 13bp. In a departure from previous practice, we now include assumed performance fees (H223 £1m and FY24 £2.5m) reflecting the more favourable environment for the enhanced passive hedging service. This increases the risk to estimates but it seems reasonable to reflect some of the potential from this episodic source of revenue.

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 1.55p and 1.20p, respectively, giving total dividends of 5.65p and 5.40p. The reduction in FY24 reflects a lower performance fee assumption following the relatively high level of performance fees crystallised in H123.

The group figure for net cash and equivalents at end September was £17.7m compared with cash and money market instruments of £17.3m at the year end. 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. 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.

As in our last note in July, it is interesting to consider a scenario that could generate over £60m in revenue and a 40% operating margin in line with the group’s targets for FY25. 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 $91bn compared with existing estimates of $81.2bn and $84.9bn for FY23 and FY24, respectively. We allow for a marked increase in multi-product fee rate at 30bp (compared with 18.4bp currently 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 5.6bp and 5.8bp respectively in our FY23 and FY24 estimates). Adding performance fees of £2m gives revenue just above £60m. On costs we allow for a 21% 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 £24.5m and diluted EPS of 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 33% on average, while Record shares are 6% higher, 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 within the range of multiples. Delivery of growth in line with the group’s three-year plan would bring the final year multiple below 10x. On our estimates, Record’s prospective yield (including special dividend) would be over 6% for FY23 and FY24 and, on our FY25 scenario, c 11%.