26 July 2019
By Maynard Paton
Results summary for City of London Investment (CLIG):
- These 2019 summary figures contained no surprises, as lower funds under management (FUM) throughout the year left revenue down 6% and profit down 16%.
- FUM ironically ended the year at its highest-ever level in GBP terms (£4.2b), as client money once again trickled out of the main emerging-market funds and in to other strategies.
- The overall fee rate paid by clients slid from 80 basis points to 76 basis points.
- The accounts continue to sport high margins, a robust return on equity, decent cash flow and net cash.
- The P/E is approximately 10 and the yield tops 6%, although the shares have traded on a similar rating for years. I continue to hold.
- Event link and share data
- Why I own CLIG
- Results summary
- Revenue, profit and dividend
- Funds under management
- FUM fee rates
- Income statement, balance sheet and cash flow
Event link and share data
Event: Summary results for the twelve months to 30 June 2019 published 16 July 2019
Shares in issue: 26,560,707
Market capitalisation: £114m
Why I own CLIG
- Emerging-market fund manager that employs a lower-risk ‘value’ strategy of buying investment trusts, and which does not require ‘superstar’ stock-pickers.
- Management offers regular/transparent reporting and distributes the majority of company earnings as dividends.
- A P/E of 10 and yield of 6%-plus offer upside potential should significant new clients ever bolster funds under management.
Revenue, profit and dividend
- CLIG commendably published these summary 2019 results just 12 working days following the year end.
- A lower first-half profit, a mixed Q3 statement plus monthly website updates meant the figures contained no surprises.
- Revenue fell 6% to £31.9m while operating profit dived 16% to £10.5m.
- Funds under management (FUM) actually ended the year 6% higher at $5.4b.
- However, FUM on a monthly average basis fell 3% to $5.1b. FUM dropped 9% during the first half then rebounded 17% during the second.
- Lower fee rates on FUM and greater staff costs also affected the figures (more on those later).
- The overall performance broadly matched that of 2017:
|Year to 30 June||2015||2016||2017||2018||2019|
|Funds under management ($m)||4,211||4,005||4,661||5,107||5,389|
|Operating profit (£k)||8,727||7,757||11,508||12,528||10,503|
|Finance income (£k)||205||212||82||264||894|
|Other items (£k)||-||-||-||-||-|
|Pre-tax profit (£k)||8,932||7,969||11,590||12,792||11,397|
|Earnings per share (p)||26.4||23.6||36.9||39.5||34.9|
|Dividend per share (p)||24.0||24.0||25.0||27.0||27.0|
|Special dividend per share (p)||-||-||-||-||13.5|
- CLIG continues to benefit from the Brexit-weakened GBP.
- CLIG’s revenue is collected almost entirely in USD but approximately 40% of costs are expensed in GBP — hence the much improved performances after 2016.
- The dividend was held at 27p per share. A special 13.5p per share payout was declared at the half year.
Funds under management
- FUM ended the year at its highest-ever level in GBP terms:
- In USD, CLIG’s FUM high occurred during early 2011 when total client money surpassed $6b.
- CLIG’s FUM can be divided into two main categories: i) Emerging Markets (EM), and; ii) non-Emerging Market (non-EM), which covers ‘frontier’ markets, developed markets and other themes.
- Both categories apply CLIG’s long-standing ‘value’ approach of buying investment trusts at a discount.
- Non-EM FUM has become a larger part of overall FUM during recent years:
- Non-EM funds have often attracted additional client contributions, unlike the EM funds, which have suffered net withdrawals since 2017:
- During 2019, client money generally trickled out of EM funds and trickled in to non-EM funds:
|Client flows||Q1 2019||Q2 2019||Q3 2019||Q4 2019||FY 2019|
- An irony of the growing exposure to non-EM FUM is that EM delivered a greater investment return last year than non-EM:
|Market movements||Q1 2019||Q2 2019||Q3 2019||Q4 2019||FY 2019|
- CLIG said the EM strategy out-performed because “discounts narrowed and country allocation was positive”.
- CLIG said the non-EM strategies under-performed due to “a combination of negative NAV and country allocation effects”.
- I estimate total FUM enjoyed a 3.6% gain excluding additional client contributions during 2019. My estimate for 2018 was 5.6%.
- This next table sums up the additional client contributions and general market movements experienced during 2019:
|Q1 2019||Q2 2019||Q3 2019||Q4 2019||End
- The chart below from CLIG’s 2018 annual report (point 3) shows market movements (the brown boxes) outweighing the movements from client contributions and withdrawals (the yellow boxes):
- Additional FUM through market movements and client contributions are typically (and frustratingly!) small compared to the overall level of FUM.
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FUM fee rates
- CLIG’s greater dependence on non-EM FUM may explain the group’s lower fee rate.
- Back in 2015, CLIG charged clients 85 basis points (i.e. 0.85%) on its overall FUM.
- Between 2017 and 2018, the rate slid from 84 to 80 basis points.
- Then between 2018 and 2019, the rate slid further to 76 basis points (first disclosed during Q3).
- My basic algebra suggests EM fees are levied at 90 basis points and non-EM fees are levied at 30 basis points to arrive somewhere close to the overall fee rates CLIG has declared:
- If my fee-rate algebra is accurate, the advance of non-EM FUM is not surprising given the associated fees are so much lower.
- I do wonder if non-EM FUM has been bolstered partly by EM clients switching to non-EM. The total number of clients has increased from 161 to only 169 during the last five years.
- CLIG claims its representative EM fund has out-performed its benchmark during the last 18 months following two years of prior under-performance:
- During the last three and a half years, both CLIG’s representative EM fund and its associated benchmark have gained 41%.
- During the last five and a half years, CLIG’s representative EM fund has gained 29% while the associated benchmark has gained 23%.
- CLIG claims its representative EM fund (red circles below) has enjoyed consistent first- or second-quartile performances during the last 15 years:
- Given the appealing relative performances, I question why the EM division has suffered net client withdrawals during the last three years.
- One reason could be that only three people were employed within the business development and marketing department during 2018:
- A few extra employees tasked to find new clients could easily pay for themselves if/when the extra FUM (and fees) roll in.
- The (re-)appointment of a senior business-development manager (point 4) might help stir up some new business.
Dividend-cover template and FUM/exchange-rate table
- An updated dividend-cover template accompanied these summary full-year results:
- Market ups and downs can leave left the template looking rather optimistic or pessimistic at times.
- The template does nonetheless reveal what CLIG believes could happen during the coming twelve months.
- The template expects earnings of £3.3m to be retained during the current year.
- £3.3m is equivalent to approximately 13p per share which, when added to a maintained 27p per share dividend, indicates current-year earnings might be 40p per share.
- The red dotted lines within the template show the projections at the half year, since when FUM has rebounded 17%.
- A year ago the template looked like this:
- The template back then expected CLIG to retain earnings of £2.5m during 2019.
- In actual fact, CLIG retained £1.5m. In other words, the template misjudged total earnings by £1m or 10%.
- The “key assumptions” used to construct the template expect the non-EM funds to attract a further $250m during 2020. This $250m non-EM assumption has been surpassed during the last two years.
- The same assumptions expect EM funds to attract no extra money during 2020. This zero EM assumption has been too optimistic during the last three years.
- I am pleased the “key assumptions” show overheads not increasing during the current year.
- CLIG’s updated FUM/exchange-rate table confirms the 76 basis-point fee:
- The (awful) Employee Incentive Plan (EIP) is set to pinch 5% of pre-bonus profit during the current year
- The EIP should cease this time next year.
Income statement, balance sheet and cash flow
- CLIG’s operating margin and return on equity remain high, but not as high as they have been:
|Year to 30 June||2015||2016||2017||2018||2019|
|Operating margin (%)||34.4||31.8||36.8||36.9||32.9|
|Return on average equity (%)||47.7||42.7||58.9||50.9||43.6|
- The margin reduction was due mainly to staff costs (identified under ‘human resources’, ‘profit-share’ and ‘EIP’ below) increasing 5% to almost £15m:
- As I have noted before, fund-management employees tend to enjoy higher total remuneration every year regardless of whether their business improves or not.
- Cash finished the year £6m lighter at almost £14m following a £10m dividend (including a £3.4m special payout), £3.6m to seed a REIT fund and £1.2m spent buying shares for cancellation:
- CLIG has spent £2.4m during the last three years buying shares for the employee benefit trust (EBT). This sum has been counterbalanced by £2.3m generated by staff exercising options to acquire the shares held by the EBT.
- CLIG’s balance sheet showed investments of £7.8m, of which ‘non-controlling interests’ (i.e. third-party investors) own £3.4m. Investments actually owned by CLIG are therefore £4.4m:
- Cash and net investments are therefore £18.2m, which less regulatory capital of £1.7m leaves £16.5m or 62p per share.
- CLIG’s books remain free of debt and pension obligations.
- I will look at the accounts in more detail when the full annual report is issued during September.
- My valuation sums employ CLIG’s latest FUM/exchange-rate table (see above).
- I reckon FUM at $5,389m and GBP:USD at 1.25 may lead to earnings of approximately £10.3m or 38.7p per share.
- Adjusting the £114m market cap for the near-£17m of cash and net investments, my enterprise value (EV) calculation comes to approximately £98m or 368p per share.
- Dividing that EV by my earnings guess gives a possible P/E of 9.5.
- Ignoring the cash and investments gives a potential P/E of 11.
- Note that the FUM/exchange-rate table (above) applies an EIP charge of 5%, and the EIP ought to cease after 2020.
- Applying an EIP charge of 0% instead of 5% increases my earnings estimate by almost 8%.
- While the P/E does not look expensive (with or without the EIP), bear in mind:
- these shares have rarely traded at an extended rating;
- little progress has been made attracting additional FUM and clients for some years;
- client fee rates have been sliced lower over time, while costs have been rising;
- the balance sheet has regularly carried a sizeable cash position, which in reality may be needed to reassure clients and might therefore not be ‘surplus to requirements’ for valuation purposes, and;
- Founder/chief investment officer Barry Olliff retires during December and is currently reducing his near-8% shareholding. Mr Olliff last sold at 450p and wishes to sell more at 450p, 475p and 500p (point 1).
- A notable re-rating could be hard to achieve unless the group starts to win fresh clients that bring in significant FUM.
- Perhaps the retirement of Mr Olliff may spark a more dynamic approach to attracting extra customers. The new chief exec once worked in marketing (albeit a long time ago):
- CLIG likes to distribute the majority of its earnings as a dividend. Dividend cover during the last ten years has never topped 1.5 times.
- My 38.7p per share earnings guess covers the trailing 27p per share dividend 1.43 times.
- The 27p per share dividend supports a useful 6.3% income at 430p.
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Disclosure: Maynard owns shares in City of London Investment.