We spend an enormous amount of time each year continually analysing and reviewing our portfolio holdings to identify the potential opportunities and threats that can emerge as a result of structural change. We often forget, however, that as the sole directors and shareholders in Ophir Asset Management, we ourselves are managers of a business that operates within an industry that is itself currently facing significant structural change.
Funds management globally is a sector undeniably in structural growth phase. As the global population continues to grow, develop and age, so too does the ever-increasing pool of investable assets requiring responsible fiduciary management. In Australia alone, the total capital managed by the Australian funds management industry has grown 11x in size since the introduction of compulsory superannuation in 1992. At current FUM of ~$2.8 trillion, Australia now has the largest funds management industry in the Asian region. From an already high base, superannuation funds are expected to further quadruple in size over the next 20 years.
The need for high quality investment managers has never been greater and yet portions of the industry have found themselves facing their own iPhone moment given the meteoric rise of passive and ETF investment strategies.
The growth in passive products is almost as impressive as the mass adoption of smartphones. Global ETF assets exceeded US$4 trillion as of April this year, with more than half of all US equity assets under management estimated to be under the stewardship of passive managers by January next year. To illustrate how large these pools of capital are, Vanguard - one of the largest providers of low-cost ETF and passive investment products globally - is now classified as a ‘Substantial Holder’ (holding in excess of 5% of the issued capital of a listed company) of more than 450 of the companies within the S&P 500.
The move is not bound solely to the US. In Australia, the three largest ETF / passive providers make up more than 9% of the issued capital of the top ASX 20 companies on average.
While the pools of capital drawn to passive strategies is enormous, in our view this will only serve to create greater opportunities for active, bottom-up investors over the long term. If more capital is deployed toward the average, then the opportunities to exploit pricing anomalies or to be the first mover in an emerging company will undoubtedly increase. Like an equity index, the passive investment dollar is generally also market-cap weighted and will subsequently deploy greater portions of investor capital toward larger components of an index. This isn’t an overly efficient method of capital allocation and high quality stock pickers will be well placed to capitalise on the opportunity over time.
Granted, as active managers of bottom-up, benchmark-unaware strategies we recognise we retain an obvious bias. However, we also feel we retain sufficient industry insight to recognise the value proposition provided by high quality active investment management continues to remain compelling. While the fund flow pendulum has dramatically swung the way of passive in recent years, it will be precisely this movement that creates more opportunities for outperformance from active strategies that seek to invest in businesses irrespective of where they rank in an index or underlying benchmark. Indeed, we currently own two listed businesses within the Ophir Funds that we feel are well placed to leverage off this opportunity and to the continued growth in the active management industry as a whole.
Magellan Financial Group (MFG)
The success of Magellan Financial Group (MFG) is already well documented, however we feel the business continues to be well positioned to continue on an already stellar growth path. Coincidently, July 2017 marks another auspicious 10-year anniversary – the launch of Magellan’s original Global Equity and Infrastructure funds. From small beginnings, the business now speaks for more than $50bn in actively managed funds under management, an incredible growth achievement executed over just 10 years for founders Hamish Douglass and Chris Mackay.
While the Magellan business isn’t a disrupter in the traditional sense, the management team were able to identify a substantial opportunity in the Australian market for building an international investment business at a time when the competitive landscape in Australia was in their favour. A differentiated product offering with a broad distribution strategy aimed at higher margin retail investors and offshore institutions has insulated the business from recent competitive threats and we continue to feel the business has room for further growth from here.
The introduction of new ‘Low Carbon’ strategies will add a further $40bn in incremental capacity for the business, whilst recent press reports have hinted at the possibility of another Listed Investment Company (LIC) product in the offering. The business is currently capitalising a number of recent low performance years and have surpassed previous high water marks which allow the funds to again earn performance fees. With a significant sales, investment and operations team now firmly in place, the operating leverage from every dollar of incremental FUM into the business continues to meaningfully increase from here. We remain happy shareholders in the business.
Pinnacle Investment Management (PNI)
At the smaller cap end, we also hold an investment in Pinnacle Investment Management (PNI), an ‘incubator’ investor that seeds and supports a diverse range of upcoming boutique investment managers in return for an equity share in the underlying manager. At the end of 1Q17, the business spoke for FUM of $25bn, having grown that number by $5.2bn in the previous nine months alone.
Whilst Pinnacle itself may not be a well-known name outside of the professional investment community, the fund management businesses in which they invest are likely more recognisable. Like MFG, this is a business that has demonstrated a highly capable ability in raising a substantial amount of investment capital quickly, highlighted in the Distribution team recently being recognised as ‘Distributor of the Year’ by investment research house Zenith Investment Partners. This has been further demonstrated recently in the two ~$300m LIC capital raisings for house funds Plato Investment Management and Antipodes Global Investment Partners.
The business retains substantial growth runway in terms of capacity with approximately ~$40bn in available capacity across the various funds available to be allocated. The business has made it clear that the current stable of managers is not an exhaustive list and with more talented managers looking to exit the older institutional funds management models, there will be more opportunities for the business to add new boutiques and/or retail distribution deals. Like MFG, the bulk of the staff and operational costings have already been made upfront, meaning the operational leverage again materially lifts in the coming years. We expect to see continued growth in the business from current levels.
This article is an extract from the Ophir June 2017 Investor Letter