Ashmore: I Can No Longer Watch After Clients Lose $2.8bn

03 March 2017
By Maynard Paton

Today I’m continuing my hunt for Watch List shares by revisiting Ashmore (ASHM). I first placed the company on my Watch List during March 2015.

Here are the attractions that prompted this revisit:

* Fantastic financials: The books showcase a 67% operating margin and a £601m net cash and investment hoard

* Boardroom billionaire: Management continues to be led by the company’s founder, who has £1bn riding on the share price

* Conducive (post-Brexit) currencies: Group revenue is earned almost entirely in USD while costs are expensed mostly in GBP

As usual, I’m applying a question-and-answer template to help me pinpoint companies that match the criteria set out in How I Invest. I’m looking for as many Yes answers as possible.

Activity: Fund manager specialising in emerging-market debt
Website: www.ashmoregroup.com
Share price: 350p
Shares in issue: 707,372,473
Market capitalisation: £2,476m

Does the business boast a respectable track record?

I’m not sure.

ASHM was established during 1992 when Australia and New Zealand Banking Group created a new fund-management division within its emerging-market team.

Senior executives completed a management buy-out in 1999 for £10m and the business claims to have been one of the first to offer investors “direct access to a broad group of emerging economies”.

Funds under management (FUM) stand currently at $52bn, are split 90%/10% institutional/retail, and are invested mostly in emerging-market debt with the rest in other emerging-market asset classes.

ASHM joined the main market during 2006 and although I can’t locate the company’s flotation document on its website, Companies House does carry all the annual reports from 1999 onwards.

The archives show that revenue was £30m and operating profit was £22m during the group’s first full year of operation, with greater client money subsequently lifting revenue to £212m and operating profit to £140m.

Looking at the last 15 years, ASHM’s average compound rate of expansion has been impressive. However, the group’s progress during more recent times has not been so spectacular:

2011 to 20162006 to 20162001 to 2016
Revenue CAGR(9.2%)4.4%13.9%
Operating profit CAGR(10.4%)3.5%13.2%
Dividend per share CAGR2.8%--

The group has in fact gone backwards since 2013, at which point client money had reached a $77bn peak. Operating profit declined during 2014 and again in 2016, with earlier setbacks reported during the general market downturns of 2002 and 2009.

All told, the last five years have witnessed somewhat mixed financial progress:

Year to 30 June20122013201420152016
Management fees (£m)302.6316.0283.1250.2197.1
Performance fees (£m)25.433.43.113.310.4
Other revenue (£m)6.26.27.94.64.1
Total revenue (£m)334.2355.6294.1268.1211.6
Distribution costs (£m)(3.7)(4.8)(4.6)(2.9)(1.2)
Foreign-exchange movements (£m)2.84.7(26.6)18.122.1
Net revenue (£m)333.3355.5262.9283.3232.5
Operating profit (£m)225.9228.3165.0183.8140.2
Other items (£m)(0.8)3.62.8(4.4)(4.0)
Finance income (£m)18.125.72.51.931.3
Pre-tax profit (£m)243.2257.6170.3181.3167.5
Earnings per share (p)26.8229.9819.2920.2519.13
Dividend per share (p)15.0016.1016.4516.6516.65

I noted two years ago that a couple of factors had curtailed ASHM’s achievements:

1) lower performance fees, and;
2) lower management fees as a proportion of client funds under management.

The table above shows that lower performance fees continued during 2014 and 2015.

Meanwhile, the table below shows management fees as a proportion of client funds under management continue to decline, too:

Year to 30 June20122013201420152016
Management fees (£m)302.6316.0283.1250.2197.1
Management fees ($m)475.3487.9454.6391.3289.1
Average FUM ($bn)63.972.275.266.451.8
Management fee rate (basis points)74.467.660.558.955.8

(For some extra context, ASHM’s management fee was 95 basis points and 87 basis points of client money during 2010 and 2011 respectively.)

Both of these factors still lead me to believe that some clients have become disgruntled with their ASHM-run portfolios.

Revisiting this next table is interesting — it shows exactly how ASHM has seen its client assets reduce from $65.7bn to $53.6bn between 2012 and 2016:

Year to 30 June20122013201420152016TOTAL
Start FUM ($bn)65.863.777.475.058.9
Performance ($bn)(3.4)0.35.1(6.0)1.2(2.8)
Net client subscriptions ($bn)1.313.4(7.5)(9.5)(7.5)(9.8)
Reclassifications ($bn)---(0.6)-(0.6)
End FUM ($bn)63.777.475.058.952.6

My sums indicate average client funds of $66bn over the five years have produced an aggregate investment performance loss of $2.8bn.

I am not sure what returns ASHM’s clients expect from emerging-market debt, but that negative figure does not look great to me. No wonder a net $10bn has been withdrawn by clients since 2012.

Anyway, at least ASHM’s dividend has never been cut since the flotation. The income statement has been free of exceptional items, too.

Has the business grown mostly without acquisition?

Yes.

ASHM has acquired just one business since the flotation. During 2011, the group purchased an emerging-market equity fund manager with $9.7bn of client money for £93m.

Has the business mostly self-funded its growth?

Yes.

The latest balance sheet displays share capital of £16m versus earnings retained by the business of £657m.

Does the business possess an asset-strong balance sheet? 

Yes.

At the last count, cash was £368m, various investments came to £233m while debt was zero. Regulatory capital required to run the business is £100m.

There are no defined-benefit pension obligations.

Does the business convert profits into free cash?

I believe so.

Year to 30 June20122013201420152016
Operating profit (£m)225.9228.3165.0183.8140.2
Depreciation and amortisation (£m)7.87.54.95.35.1
Net capital expenditure (£m)(2.6)(1.9)(0.4)(0.7)(0.6)
Working-capital movement (£m)---15.25.1
Net cash and investments (£m)491.7575.1549.7572.3597.7

Prior to 2015, ASHM presented its cash flow statement using the somewhat rare ‘direct’ format that did not disclose working-capital movements entirely. Nonetheless, the full working-capital movements that ASHM has since disclosed have been favourable.

Meanwhile, the group’s depreciation and amortisation expense more than covers the actual cash spent on fixed assets. Indeed, it is somewhat remarkable that a business with fixed assets of just £2m could produce an operating profit of £140m last year.

All told, I get the impression ASHM enjoys respectable cash-conversion qualities.

I guess ASHM’s cash and investments having improved by almost £140m between 2011 and 2016 — and some £549m distributed as dividends in the meantime — suggest this business does not report ‘hollow’ earnings.

Does the business enjoy a competitive advantage?

I’m not sure.

For what it is worth, ASHM’s 2016 annual report cites specialist skills, disciplined committees and distinctive remuneration as being among the group’s favourable characteristics:

Value-oriented active fund management
The diversity and inefficiencies of the asset class provide significant investment opportunities, but also require specialist, active fund management skills to navigate volatile market cycles.

Committee-based investment processes, not a star culture
Disciplined Investment Committees manage portfolios through the application of consistent value-based investment philosophies.

Distinctive remuneration philosophy
Fixed salaries are capped and variable pay is linked to Group profitability. Rewards are biased towards long-dated equity, supporting the ‘team-based’ culture and encouraging employee retention.

The group currently claims more than 80% of client money has outperformed over three and five years.

That said, customer money in the fund-management sector is generally attracted or withdrawn based on investment results — which as we all know can fluctuate! Two years ago, just 40% of client money had outperformed over three and five years.

As I noted two years ago, one operational advantage ASHM does enjoy is incredible economies of scale.

Operating margins have averaged a stratospheric 65% during the last five years, in part due to staff members being able to handle sizeable funds under management:

Year to 30 June20122013201420152016
Average FUM ($bn)63.972.275.266.451.8
Number of employees251280290293277
FUM per employee ($m)254.6257.9259.3226.6187.0

However, the amount of money each employee has been handling has reduced over time. Other employee ratios have been trending in the wrong direction, too:

Year to 30 June20122013201420142014
Total revenue (£m)334.2355.6294.1268.1211.6
Employee cost (£m)(73.0)(82.3)(66.1)(67.2)(59.7)
Employee cost/total revenue (%)21.823.122.525.128.2
Average employee cost (£)290,837293,929227,931229,352215,523
Total revenue/employee (£)1,331,4741,270,0001,014,138915,017763,899

At least the cost of the average employee has not risen, thanks in part to ASHM’s ‘variable’ pay structure.

Similar to City of London Investment and Record, ASHM employs a bonus scheme that’s determined by the yearly profit level. ASHM staff take 20% of pre-bonus profit for themselves.

Does the business produce a respectable return on equity?

Yes.

Return on average equity for 2016 was £128m/£675m = 19%. Strip out the cash and investments from the equity base and the 2016 calculation tops 100%. My sums indicate similarly eye-popping numbers for earlier years.

Does the business employ capable executives?

That depends on your view of ASHM’s track record.

Mark Coombs led the aforementioned management buy-out in 1999 and has since overseen ASHM’s progress as chief executive. Mr Coombs is 56 years old, so succession plans are not an immediate requirement at present.

Does the business employ good-value-for-money executives?

I am not sure.

Since ASHM’s flotation Mr Coombs has received a £100k basic salary  — a very low wage for a FTSE 350 chief exec.

However, Mr Coombs has collected bonuses and share awards totalling a substantial £28m during the same time. Though cash bonuses were not declared during the ‘setback’ years of 2009 and 2014, I am surprised the lower profit for 2016 did provide Mr Coombs with an extra £709k payment.

Does the business employ owner-orientated executives?

Yes.

Mr Coombs boasts a 41%/£1bn stake, which I trust gives him the ‘owner’s eye’ when it comes to looking after all ASHM shareholders.

What’s more, Mr Coombs’ investment is currently delivering a £47m annual dividend, making him very much dependent on ASHM’s payout for his total income.

I am pleased ASHM’s option scheme is still under control via an employee benefit trust (EBT). The EBT holds 41 million shares (5.6% of the share count), which will be released to employees as and when they exercise their 40 million options.

To prevent substantial dilution from exercised options, ASHM regularly buys shares for the EBT. Some £135m has been pumped into the trust during the last five years and I am happy that expense has been just about reflected by the £101m aggregate cost within ASHM’s income statements.

Does the business enjoy reasonable growth prospects?

I’m not sure.

Certainly ASHM’s clients have not rushed in to place more money into the group’s funds — interim results published last month showed assets under management stagnant at $52bn.

Nonetheless, ASHM remains upbeat about the potential investment upside for emerging markets:

“The prospects for Emerging Markets in 2017, and over the longer term, are very attractive. The fundamental strength and flexibility of the economies contrasts sharply with much of the developed world, and these characteristics have enabled Emerging Markets to adjust and to withstand the global economic challenges faced over the past three to five years, many of which originated in developed nations.”

“Emerging Markets’ economic growth is expected to accelerate this year, both against recent experience and versus developed countries.

“Despite the strong performance in 2016, Emerging Markets assets remain attractively priced, with substantial further US interest rate increases already anticipated in valuations.

“Allocations to Emerging Markets are low and underweight and in some cases even below investors’ own target levels, and therefore should increase as Emerging Markets continue to deliver strong absolute and relative investment returns.”

That said, ASHM has consistently been bullish on emerging markets. Here are a few choice quotes from the 2011-2016 annual reports:

2011
Emerging markets equities valuations suggest the upcoming quarter may represent a good entry point with earnings forecast to grow strongly over the medium term.

The opportunity for raising AuM from both developed country and emerging markets sources as they increasingly come to realise the attractiveness of the emerging markets asset classes over developed market alternatives, remains a compelling one.

2012
In summary, more and more investors are seeing Emerging Markets debt as an alternative to fixed income in general, not just developed world corporate credit. Indeed, with yields in the developed world either high for a good reason or yielding next to nothing, Emerging Markets debt looks highly attractive.

Furthermore, after a period of relatively poor performance and flows, Emerging Markets equity, which has long been an established asset class, looks to be ripe for a good year given relatively low valuations.

2013
Dedicated long-term investors recognise these characteristics of the Emerging Markets asset class, and can take advantage of the asset re-pricing that results from technical factors rather than a change in fundamentals.

Demand for Emerging Markets themes with relatively low correlation to the US treasury market will continue: equities, local currency assets, blended debt and shorter duration, higher yielding corporate debt offer attractive prospective returns.

2014
Emerging nations are generally in good health and in aggregate are expected to grow faster than the developed world, thereby continuing to increase their importance to the global economy and exposing underweight allocations.

Rising geo-political risks in certain parts of the Emerging Markets world, as well as elections taking place in key economies, have led to uncertainty and hence price volatility in the short term.

This environment provides opportunities to deliver longer-term performance for managers such as Ashmore that employ a disciplined, fundamental approach to assessing economic, political and market risks, and that continue to invest over the cycle.

2015
Across global markets there is likely to be convergence between asset prices and fundamentals over the next few years. In Developed Markets, this is likely to take the form of inflation and currency devaluations rather than real rate increases, austerity and reforms.

In contrast, after a period of continued volatility, Emerging Markets’ asset prices appear to be discounting a much worse fundamental outlook than is likely to arise, even with higher US interest rates. This suggests that the rational asset allocator will increasingly shift towards Emerging Markets, where there is greater value, more supportive fundamentals, and a need for investors to address underweight positions.

2016
The volatility and weakness experienced recently in Emerging Markets assets, when se against improving economic fundamentals, has provided good investment opportunities for Ashmore’s value-based processes.

Ultimately, though, the value available in Emerging Markets contrasts starkly with current pricing levels for many developed world markets, and this will encourage investors to address their weightings in Emerging Markets, resulting in stronger client flows over time.

I suppose it is natural for fund managers to always be positive about their particular asset classes.

And yet since 2011 — and despite all of the optimism — ASHM’s funds under management have dropped from $66b to $52bn, with about $10bn withdrawn by clients.

Does the share price stand a good chance of becoming a bargain?

I’m not sure.

I’ve calculated ASHM’s enterprise value (EV) to be its £2,476m market cap less its cash and investments of £601m… but plus the group’s regulatory required capital of £100m.

That gives a total of £1,975m or 279p per share.

Assuming i) client funds stay at $52bn; ii) the management-fee rate remains at 54 basis points, and; iii) £1 continues to buy $1.25, I reckon annual management fees could now be running at £225m.

Assuming no performance fees are collected and other costs remain the same, I reckon operating profits could be £111m and earnings might be around 16p per share.

The potential P/E on my EV and EPS calculations is therefore 279p/16p = 17. The trailing 16.55p dividend supports a useful 4.7% income, too (although the dividend is not entirely covered by my EPS estimate).

(For what it is worth, City brokers are predicting earnings to bob between 18p and 22p per share during 2017, 2018 and 2019. I presume those estimates include guesses for performance fees and gains on investments, both of which are not guaranteed to occur each year and have been excluded from my own sums.)

For some perspective on the present rating, this time last year a wider stock-market rout had dragged ASHM’s shares down to as low as 200p.

My sums then pointed to an underlying P/E of about 10 — which at the time did not strike me as an unquestionable bargain. During previous market downturns, I have witnessed fund-management businesses valued on single-digit multiples.

Is it worth watching Ashmore?

I don’t think so.

I wrote two years ago that ASHM offered three important features for me — the presence of a founder-entrepreneur at the helm, some very impressive accounts and a share-price rating that may have offered reasonable value.

While the founder-entrepreneur and the impressive accounts remain, I don’t think the share-price rating offers reasonable value right now.

More to the point, I wasn’t tempted to buy even when the share price had slipped to 200p last year. I had thought the valuation could go into single digits.

Since then, I have become somewhat more wary of asset-management businesses.

My two holdings in the sector — City of London Investment and Record — have both suffered from stagnant client money… yet that has not stopped the pair from snaffling cash from shareholders to raise employee costs significantly.

Indeed, I do wonder sometimes whether these two companies — and the fund-management sector in general — are run for the benefit of staff ahead of ordinary shareholders.

As such, it would not surprise me if ASHM’s workforce started agitating for greater pay despite the group’s performance having gone nowhere for years.

Anyway, it just seems to me ASHM will only start to make progress when there is a prolonged upturn in its chosen emerging markets. Unfortunately, I have not found any evidence to indicate ASHM can attract regular client money through its own processes when those markets are more challenging.

And I suppose those declining management-fee rates must be telling me something about how clients are valuing ASHM’s services.

All told then, despite the billionaire in the boardroom, the massive margins and some conducive post-Brexit currency advantages, I simply can’t muster the enthusiasm for monitoring ASHM — and its standstill funds — any further.

Maynard Paton

Disclosure: Maynard owns shares in City of London Investemnt and Record, and does not own shares in Ashmore.

3 thoughts on “Ashmore: I Can No Longer Watch After Clients Lose $2.8bn

  1. Walter Hin

    Interest rates rising in the U.S. is causing the sell-off in emerging markets debts, while equities valuation remain stagnant. And with President Trump spending spree in America interest rate could continue rising.
    My other concerns are possible trade barriers, especially with Asian Economies.

    Ashmore is like Aberdeen are funds specialising in emerging economies. I’m bearish on emerging economies, especially China because of its credit-fuelled growth. Debt is over 300% of GDP (some analysts pencilling in 350% of GDP)
    Ashmore funds outflow happened in the same period when China devalues the RMB by 3%. And last year lost 6% against the USD. Capital is leaving the country by the hundreds of billions USD, just when it is most needed to shift the economy from investment to consumption.

    A slowdown in China has a detrimental effect on other emerging economies including Brazil and South-East Asia.

    At the same time, America is raising interest rates, adding fuel to the strong Dollar. The biggest worry is trade tensions between the U.S. and China, given President Trump position on this issue.
    Given the stock market at all times highs, I wouldn’t want to bet on funds right now because they tend to do worst if a financial crisis erupts.

    Reply
    1. Maynard Paton Post author

      Hello Walter

      Many thanks for the Comment. I must admit to not knowing the full story of emerging markets at present, so your post was very helpful.

      Maynard

      Reply

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