CITY OF LONDON INVESTMENT: Profit Share Rising To 26% While FY 2023 Revenue Slides 16% Raises Further Questions About Employee Pay,  Future Margins And Viability Of 10% Dividend Yield

15 December 2023
By Maynard Paton

FY 2023 results summary for City of London Investment (CLIG):

• Ongoing market “headwinds” caused average funds under management (FuM) to decline 12% to $9.2b, which led to revenue dropping 16% and profit diving 29%.

• New USD reporting may expose CLIG’s prior progress benefitting from a weaker GBP, with the GBP dividend unchanged since FY 2021 versus the USD equivalent down 11%.

• Significant new clients remain very elusive, with FuM outflows of $357m during this FY prompted by higher deposits rates and CLIM funds returning 3% (or less) five-year CAGRs.

• The profit-share proportion increasing from 24% to 26% during a difficult FY raises further questions about employee pay and the likelihood of additional pressure on profit margins, earnings and ultimately the dividend. 

• While CLIG’s own projections point to earnings of 34p per share that just about support the 33p payout and 10% yield, achieving the group’s total-return KPI to FY 2024 is looking increasingly uncertain. I continue to hold.

Contents

• News links, share data and disclosure
• Why I own CLIG
• Results summary
• Functional and reporting currency change
• Revenue, profit and dividend
• Funds under management: inflows and outflows
• Funds under management: capacity limitations and growth plans
• Funds under management: investment performance
• Funds under management: net fee rates
• Exchange-rate/post-tax profit matrix, other assumptions and employees
• Financials
• Valuation

News links, share data and disclosure

• Annual report and presentation for the twelve months to 30 June 2023 published 18 September 2023; 
• Board and management update published 03 October 2023, and;
• Q1 2024 trading update published 13 October 2023.

• Share price: 320p
• Shares in issue: 50,679,095
• Market capitalisation: £162m

• Disclosure: Maynard owns shares in City of London Investment. This blog post contains SharePad affiliate links.

Why I own CLIG

• Fund manager that employs a “risk-averse” strategy of buying investment trusts at attractive discounts through a team-based approach (point 1) .

• Accounts showcase a high 39% margin, significant net cash and ability to distribute majority of earnings via dividends.

• Yield of 10% offers meaningful income potential with capital-gains upside linked to a wider market recovery — or winning extremely elusive new clients!

Further reading: My CLIG Buy report | All my CLIG posts | CLIG website

Results summary

Functional and reporting currency change

• July’s Q4 update had told shareholders this FY would be the last to report using GBP:

“The functional currency of the Company and the presentational currency of the Group will change to US dollars with effect from 1 July 2023.

The Group’s revenue is almost entirely US dollar based and the Board believes that this change will provide investors and other stakeholders with greater transparency of the Group’s performance and reduced foreign exchange volatility.

There will be no change in the Group’s dividend policy, and dividends will continue to be declared in GBP with an option for shareholders based in the US to elect to receive dividends in USD.”

• The switch to USD reporting makes sense. After all, this FY disclosed:
  • 96% of clients (by revenue) are located in the United States;
  • 65% of expenses are incurred in USD, and;
  • 52% of CLIG shares are owned by investors based in North America.

• CLIG helpfully compared the GBP- and USD-denominated versions of this FY:

• GBP net fee income dropped 6%, while USD net fee income dropped 15%. 

• GBP operating profit dropped 27%, while USD operating profit dropped 35%.

• CLIG provided complete USD-denominated income statements, balance sheets and cash flow statements for both this FY and the comparable FY.

• For FYs prior to FY 2022, I have translated the original GBP performances into USD using the average GBP:USD rate that prevailed during each FY.

• Although my translations are estimates and will not be entirely accurate, they do underline how CLIG’s GBP progress has benefitted from a stronger USD. 

• For example, GBP revenue between FYs 2013 and 2023 advanced 95%…

• …while USD revenue increased 49%:

• Furthermore, GBP adjusted operating profit between FYs 2013 and 2023 gained 166%… 

• …while USD adjusted operating profit improved 102%:

• GBP:USD averaged 1.57 during FY 2013 and 1.20 during FY 2023:

• CLIG’s dividend history gives further perspective to the GBP-USD comparison.

• The GBP payout was 24p per share for FY 2013 and 33p per share for this FY — an increase of 38%:

• But a USD payout would have gained only 6% — from 37.9 US cents to 40.1 US cents — during the same period:

• Indeed, while CLIG has held its dividend at 33p per share between FY 2021 and this FY…

• …shareholders converting their 33p per share dividends into USD have suffered an 11% income decline (from 45.3 to 40.1 US cents)!

• CLIG said dividends would continue to be declared in GBP, although I suspect CLIG will first determine the payout using USD. After all, earnings will now be determined in USD and dividend payouts are of course are funded by earnings.

• CLIG’s dividend policy remains to cover the payout by 1.2x using adjusted earnings over a rolling five-year period. 

• CLIG said:

“This [dividend-cover] policy was introduced in 2014 and was reviewed in 2019. No changes were proposed. It was designed to incorporate the required flexibility to deal with the potential volatility of CLIG’s income.
…
This is not a long-term policy. Rather, it will be reviewed after five years and every five years thereafter.” 

• A dividend-policy review occurs next year, and may well prompt a rethink about:
  • Measuring dividend cover with USD earnings and a GBP payout, and;
  • Applying a 1.2x cover over rolling five-year periods.

• CLIG’s own projections indicate very thin dividend cover for FY 2024…  

• …and further FuM declines will increase doubts about the current 33p per share payout (see Valuation).

• CLIG’s headline progress beyond this FY will no longer have a stronger USD to bolster the GBP performance.

• CLIG’s (slower) USD progress may be another reason why the share price has barely moved during the last ten years:

• Starting with this FY, my blog write-ups will evaluate CLIG’s performance on a USD basis. Maybe I should have looked at CLIG in USD terms a lot sooner!

Revenue, profit and dividend

• This FY was never going to excite after:
  • The preceding H1 revealed standstill funds under management (FuM), and;
  • April’s Q3 update and July’s Q4 update indicated FuM had not changed significantly during H2.

• FuM gained 3% during Q3 and remained unchanged during Q4 to leave FuM at $9.4b, up 2% on the comparable FY:

• FuM averaged $9.5b during H2 versus $9.0b during H1. FuM averaged $9.2b during the FY, 12% below the $10.5b average for the comparable FY.

• CLIG reiterated the market “headwinds” cited during the preceding H1:

“These [headwinds] included labour shortages, supply chain disruptions, and the war in Ukraine which led to steep declines in global stock and bond markets in 2022. More recently, the impact of higher interest rates and a weakening US commercial real estate market contributed to bank failures and credit rating downgrades of a number of US regional banks.” 

• July’s Q4 update estimated profit before amortisation and tax for this FY to be “approximately £23.4m”.

• Profit before amortisation and tax was in fact below the projected £23.4m at £23.2m. 

• The lower average FuM during this FY caused FY revenue to fall 16% to $68.7m: 

• H2 revenue declined an estimated 9% to $35.0m.

• Lower fee rates also hurt revenue. The average net fee margin (i.e. after commissions and other direct costs) reduced from 73 to 72 basis points (see Funds under management: net fee rates).

• CLIG does not distinguish revenue from its original City of London Investment Management (CLIM) division and its £102m merger partner Karpus Investment Management (KIM).

• However, Companies House reveals CLIM reported FY 2023 revenue of £34.5m, which may translate to approximately $41.5m.

• KIM revenue for this FY may therefore have been $27.2m:

• My estimates suggest CLIM revenue fell 18% and KIM revenue declined 12% during this FY.

• Excluding amortisation of $5.6m associated with the KIM merger, FY operating profit was $26.5m and 29% less than the comparable FY ($37.4m).  

• My estimates indicate:
  • H1 operating profit excluding KIM amortisation was $13.6m and 36% lower than the comparable H1 ($21.2m), and;
  • H2 operating profit excluding KIM amortisation was $12.9m and 20% lower than the comparable H2 ($16.1m):

• The sizeable FY profit shortfall versus the comparable FY reflected revenue sliding $12.8m and costs reducing by only $2.0m.  

• Following this FY, CLIG’s Q1 2024 update during October admitted FuM had declined a further $543m to $8.9b (see Valuation).

• CLIG referred to its dividend-cover policy when declaring an unchanged 22p per share final payout:

“On the basis of unchanged dividend payments totalling 33p for the year as a whole, the cover ratio for the single year is 1.09, whereas the rolling five-year cover ratio, at 1.24, will remain marginally ahead of the 1.2 target level. Accordingly, your Board is recommending the payment of a final dividend of 22p per share…“

• The 33p per share annual payout has now been declared for three years:

• I am not sure if CLIG is calculating its five-year dividend-cover sums consistently. The slides showed FY 2020 adjusted earnings to be £7.6m:

• But the FY 2021 accounts declared FY 2020 adjusted earnings to be £9.5m:

• Rolling five-year dividend cover using £9.5m rather than £7.6m for FY 2020 comes to 1.29x.

Funds under management: inflows and outflows

• CLIM’s FuM can be divided into two main categories:
  • Emerging Markets (EM), and;
  • Other strategies, which cover:
    • Developed (or “International“) markets outside the United States;
    • “Opportunistic Value“;
    • “Frontier” markets, and;
    • Seeded funds (REITs and “Global“).

• Both categories apply a long-standing value approach of buying UK- and US-listed investment trusts at attractive discounts and often taking an activist stance. CLIM customers are primarily institutional, although an EM fund-of-funds is offered to retail investors through intermediaries.

• KIM meanwhile manages fixed-income portfolios while also applying a value/discount approach to US investment trusts. KIM clients are mostly high-net worth individuals.

• For years CLIG has struggled to attract significant new client money.

• The (very thin) red bars on the chart below show new client money has been minimal since FY 2015: 

• Indeed, this FY witnessed net withdrawals of $357m that negated the net inflows of $102m enjoyed during the comparable FY…

• …and has left aggregate net outflows since FY 2015 at $249m:

• CLIG blamed higher interest rates and long-term EM underperformance for the lack of new CLIM money:

“With risk-free rates increasing, exposure to riskier asset classes are naturally being reduced by institutions. This is especially the case with EM and INTL, which are much further up the risk scale compared to US fixed income.“

“EM returns now lag US equities over two decades causing “EM fatigue” resulting in fewer new institutional mandates generated in the US.”

• KIM withdrawals were also blamed on higher interest rates tempting clients to invest elsewhere:

“…ongoing outflows occurred via lost accounts to attractive deposit rates that are FDIC-insured, individual expenses, taxes and required minimum distributions from retirement accounts.“

• KIM’s clients withdrew a net $129m during this FY to take total net KIM withdrawals since the merger to $430m:

• KIM has yet to report a material net quarterly inflow of client money since the merger. Management during the 2022 AGM claimed KIM suffers “natural” outflows of $100m a year through clients withdrawing capital and income for retirement. 

• FY KIM FuM at $3.4b remains less than the $3.6b held at the time of the (October 2020) merger.

• Alongside the $430m leaving KIM, CLIM clients have withdrawn a net $93m since FY 2016:

• Extra CLIM money received since FY 2017 has been directed entirely towards Other strategies, with consistent yearly net outflows from EM.

• In fact, this FY witnessed outflows of EM money extending to 14 of the last 16 quarters:

• Mind you, after enjoying net inflows of client money during five of the previous six FYs, Other strategies witnessed net outflows of $22m during this FY.

• This FY’s inflows and outflows had little effect on how FuM is split, with 38% still in EM, 37% still in KIM and 25% still in Other strategies:

• 38% is the lowest proportion of EM FuM in CLIG’s history. 

• EM funds represented 90% of client money during FY 2017, since when CLIG has deliberately diversified its FuM by developing the Other CLIM strategies and undertaking the KIM merger.

• At least CLIG’s largest client appears not to have withdrawn too much money during this FY. Its gross FY (GBP) fees declined 7% to match the FY (GBP) revenue decline:

“Included in revenues are fees of £5,402,756 (2022: £5,825,226) which arose from fee income from the Group’s largest client. No other single client contributed 10% or more to the Group’s revenue in either of the reporting periods.”

• Many CLIG clients are encouragingly loyal to the group. A fair number have employed CLIM or KIM for more than ten years:

• Emphasising the lack of new client money, the 173 CLIM clients served before the KIM merger compares to 161 for FY 2014. 

Funds under management: capacity limitations and growth plans

• CLIG said all of its CLIM strategies could accept extra client money:

“All investment strategies are open and have capacity at a time when attractive discounts across the closed-end fund universe are the focus of marketing efforts to consultants, institutional and wealth management clients“

• Mind you, the presentation reminded shareholders the EM strategy has “capacity” limitations:

• Capacity problems occur when client money becomes too large to outperform because of the restricted size of the target universe of stocks.

• Available capacity of $300m for EM is equivalent to only 8% of total EM FuM of $3.6b.

• At least the powerpoint reiterated the International and Opportunistic Value strategies could handle extra client money of $2b, which is almost double the $2.2b FuM invested in such approaches.

• CLIG continues to believe $300m of new client money can be attracted during FY 2024:

• An extra $300m is equivalent to only 3.2% of total FY FuM of $9.2b.

• Expecting new client money of $250m for CLIM is still not completely outrageous; CLIM attracted net inflows of $338m during FY 2020 and $265m during FY 2015.

• Continuing to expect any new KIM money seems ambitious given the division has suffered net withdrawals of $430m since the October 2020 merger.

• CLIG said a new appointment was tasked with lifting FuM:

“The integration of KIM is now complete. What remains is to leverage the strengths of the Group in order to raise new FuM across the Group. In this regard, we created a new position – Head of Corporate Partnerships – to deepen our existing client relationships, particularly as baby boomers transfer wealth to the next generation, and build new partnerships with professional organisations. This individual, who has over twenty years of experience in the field, is also responsible for branding opportunities, unique client experiences, and increasing the profile for the Group.” 

• Prompted “primarily [by] retirements”, KIM has recruited a number of new client-facing employees:

“We invested in the KIM business… A marketing support team was set up to coordinate relationships with investment platforms and assist with on-boarding clients from new relationships. A dedicated manager of the Relationship Management team was hired to build a more effective system of oversight and reporting on activities. Two experienced Relationship Managers were hired to develop new client opportunities, including those related to generational wealth strategies.”

• I do wonder whether CLIG should outsource its promotional efforts to a more capable marketing organisation. 

• After all:
  • Buying investment trusts is not the most glamorous of equity strategies;
  • CLIM’s heritage — emerging markets — has underperformed long term, and;
  • The group’s “team approach” does not lend itself to the inherent marketing advantages of employing a super-star investor.

• CLIG previously employed North Bridge Capital to help promote its funds, until marketing was brought in-house during FY 2009:

(AR 2009): “Towards the end of 2008 a marketing manager was appointed to implement our decision to bring our US marketing in-house, and ultimately therefore to avoid the commissions which we have historically paid to North Bridge Capital who have served us well since we started the US marketing activity. He will be responsible for developing direct relationships with the consultant industry which advises institutional investors.” 

• Commissions to North Bridge represented 15% of revenue during FY 2009. 

• Assisted by North Bridge, CLIM FuM between FYs 2004 and 2008 went from less than $1b to almost $5b…

• …yet during the next 15 years (without North Bridge) CLIM FuM has climbed to only $6b. (North Bridge may no longer exist.)

• KIM in contrast utilises the services of external investment advisers. Sales commissions for this FY were $1.8m, which I estimate to be 8% of KIM’s FY revenue.

• KIM’s FuM has shown greater growth over time:

• Since FY 2010, KIM’s FuM has compounded at an average 5.0% a year while CLIM’s FuM has compounded at an average 2.3% a year.

• CLIG may argue external marketing could attract the wrong type of ‘hot money’ clients, although the line “A few fund managers have encouraged hot money. CoL avoids it” has not been used in a CLIG presentation since 2019.

• CLIG’s seeded funds have yet to attract significant client money. 

• Two REIT funds were seeded during January 2019, and FuM deemed “Other/REIT” was $88m at this FY.

• CLIG’s seeded investments were carried at $10m, and my reading of the 2023 annual report indicates the group’s EM REIT may have $25m of client money and the two other seeded funds have no client money.

• While the preceding H1 suggested CLIG was prepared to buy somebody else’s FuM…

“We will also continue to evaluate external business opportunities that may appear in the aftermath of a challenging 2022 for many investment advisers.“

• …this FY did not mention any potential acquisition activity. 

Funds under management: investment performance

• CLIG described a largely positive (relative) investment performance for this FY:

“Despite wider discounts for all CEF strategies, investment performance was ahead of benchmark for the bulk of CLIM’s assets for the year ended 30th June 2023 due to strong NAV performance in the Emerging Market (EM) strategy. The International (INTL) strategy was slightly behind benchmark over the period while the Opportunistic Value (OV) strategy outperformed. KIM’s taxable fixed income, conservative balanced and SPAC strategies outperformed their market indices over the period, while equity strategies lagged their benchmarks.” 

• The 2023 annual report small-print claimed:

“Our investment horizon is five years, and over this period the three strategies that make up ~99% of CLIM’s Funds under Management are all outperforming their peers and benchmark. Long and short-term performance remains solid, with the KIM investment process continuing to add value on behalf of clients in the face of volatile markets.”

• Contrary to that small-print, this FY did not show all three CLIM strategies outperforming over the last five years.

• The EM and International approaches have indeed outperformed their associated benchmarks during the last five years…

• …and even the last ten years:

• But Opportunistic Value has underperformed during the last five years (but has outperformed during the last ten).

• The EM and International performances reveal an unusual phenomenon: the associated benchmarks are fourth-quartile performers over both five years and ten years.

• Benchmarks languishing in the fourth quartile may also explain why CLIM has struggled to attract new client money — lots of rival funds within the same sector can also claim benchmark-beating returns.  

• Note that the EM and International approaches are within the top two quartiles over ten years, but are within the third quartile over five years. Their relative performances seem therefore to have subsided of late, which may also explain the lack of new client money. 

• CLIM’s website underlines the subsiding investment performance.

• The EM strategy has returned a 1.2% compound average over five years and 2.7% over ten:

• The International strategy has returned a 3.0% compound average over five years and 6.0% over ten:

• The Opportunistic Value strategy has returned a 1.6% compound average over five years and 4.3% since its 2014 inception: 

• KIM’s performances have been greater and more consistent than those of CLIM.

• KIM’s Fixed Income for example has returned a 5.3% compound average over five years and 5.1% over ten:

• Equity Management has meanwhile returned a 7.4% compound average over five years and 8.5% over ten:

• And Conservative Balanced (a mix of fixed income and equities) has returned a 5.7% compound average over five years and 6.4% over ten:

• CLIG’s investment returns — and those of the group’s benchmarks — trailed the major world indices by some distance during this FY:

• References to “bubble” and “bandwagon” were employed to explain the lower returns for clients versus the global markets:

“[Today,] we find that the “magnificent-seven” stocks are valued at US$11 trillion or twice the level of the entire Japanese stock market and more than 20% of the entire US stock market. Whether or not this has taken this handful of companies into unsustainable “bubble” territory is for others to decide but in the six months to 30th June 2023, they accounted for more than 70% of the rise in the S&P 500 index, underlining the degree to which the recent strength in US equities has been driven by a narrow and powerful “Artificial Intelligence (AI)-bandwagon”. 

• The S&P 500 has been the index to own during the last decade. The iShares S&P 500 ETF (CSPX) has delivered double-digit annualised (USD) gains:

• I remain convinced prospective clients have compared CLIG’s funds to the S&P 500 rather than its chosen benchmarks, which would also explain the minimal new client money won during recent years.

• I raised the subject of the S&P 500’s strong performance during last year’s AGM.

• Management admitted at that AGM some clients had asked in trustee meetings: “What are we doing in emerging markets when the S&P 500 has outperformed?”.

• But management also suggested the S&P 500 outperformance would one day revert to underperformance: “Things can not go up for ever, they will eventually stop”.

• Hope of better times ahead for unloved investment trusts may be supported by historically wide discounts. 

• This FY claimed equity investment trusts currently trade at an overall 11% discount — a level seen previously only at times of market stress:

• Activists are becoming attracted to the sector, too, with Saba Capital in particular taking notable stakes in several UK trusts and engaging with their respective boards.

• NAV (and ultimately share price) progress at investment trusts is dictated by the underlying holdings, although I am not sure whether CLIG investigates the underlying holdings to ensure they are appropriate investments. 

• CLIG’s 2023 stewardship report instead describes the group’s attention to corporate governance and stewardship principals.

• Shareholders still await market conditions that allow CLIM/KIM to record positive returns and outperform the major global indices, which in turn could attract more clients.

• CLIG’s relative returns have not improved following this FY.

• During CLIG’s Q1 2024 (July to September 2023), CLIM’s strategies returned an estimated negative 3.8%, KIM’s portfolios returned an estimated negative 4.8% while the S&P 500 (CSPX) returned a negative 2.5% (see Valuation).

• Sad to say, but the forthcoming retirement of CLIM’s veteran chief investment officer may actually herald enhanced returns for CLIM’s clients:

“Mark Dwyer, CLIM CIO, has announced his intention to retire from the firm on 30th June 2024. Mark has been with the firm for over 20 years having served as the Head of EM CEF Strategy. We wish him the very best in his retirement.

Oliver Marschner, senior CLIM Portfolio Manager, will assume responsibility for the EM CEF Strategy from 1st January 2024.“

Funds under management: net fee rates

• CLIG said group fee rates had dropped a basis point to 72 basis points versus the comparable FY:

“The Group’s average net fee margin for the year was 72bps (2022: 73bps).

• However, April’s Q3 update and July’s Q4 update admitted fee rates had fallen a further two basis points during H2:

(Q3) “The Group’s income currently accrues at a weighted average rate of approximately 71 basis points of FuM, net of third-party commissions“

(Q4) “The Group’s income currently accrues at a weighted average rate of approximately 71 basis points of FuM, net of third party commissions.”

• This latest reduction extends a long trend of clients chipping away at fees:

• The fee rate was 86 basis points during FY 2016:

• I had previously believed the introduction of lower-fee strategies such as International had influenced the overall group fee rate.

• But with CLIG’s FuM split remaining at 38% EM, 37% KIM and 25% Other strategies during H2, I can’t see different FuM proportions affecting the overall group fee rate this time.   

• Markets generally suffered a rough calendar 2022, and I speculate clients kicked off calendar 2023 by demanding lower fees. 

• Following this FY, October’s Q1 2024 update disclosed a further fee reduction to 70 basis points:

“The Group’s income currently accrues at a weighted average rate of approximately 70 basis points, net of third party commissions.”

• Reduced disclosure also hints at clients chipping away at fees. 

• CLIG did not publish an exchange-rate/post-tax profit matrix for this FY. The matrix for the preceding H1 showed CLIM fees at 71 basis points and KIM fees at 76 basis points:

• With group fee rates now at 70 basis points, I surmise fee rates have declined significantly at both CLIM and KIM.  

• The CLIM/KIM merger document (point 5) — published only three years ago! — claimed KIM enjoyed a “fairly stable” net fee rate of 80 basis points.

• Blog reader Andrew raised the subject of reduced fee rates during this year’s AGM:

“Q3. Fee margins have clearly been under pressure. How well is the company doing in the current markets?

A3. The company is doing well, but is obviously under ongoing pressure, particularly from institutional clients and their consultants (those consultants often being paid on an incentivised basis linked to success in reducing fees charged by CLIG). Pricing with HNWIs [high net worth individuals] is more stable. The days when fees were materially higher (pre-financial crash) will not return. In essence, the company agreed that it had to grow FuM in order to generate any extra revenue.”

• I was not aware consultants employed by clients were incentivised to reduce fees paid to CLIG.  

• I believe fee rates will not stabilise until CLIM’s investment performance improves.

• After all, if typical CLIM clients have indeed earned net annual returns of c3% (i.e. 300 basis points) during the last five years, then fees at 70 basis points a year would have captured c20% of their gains.   

• In contrast, holders of that S&P 500 ETF delivering double-digit returns would have given away c1% of their gains through fees of ten (or less) basis points.

Exchange-rate/post-tax profit matrix, other assumptions and employees

• The absence of an exchange-rate/post-tax profit matrix for this FY was perhaps not surprising given the change to USD reporting.

• The matrix had previously provided a guide to possible earnings based on FuM and the GBP:USD exchange rate: 

• But the matrix also supplied useful assumptions for shareholders to track, not least fee rates (see Funds under management: net fees rates) and operating costs.

• The matrix had become somewhat obsolete following the KIM merger, as the profit-share assumption shown up until FY 2020 was dropped…

• …and the projected earnings could not be independently calculated.

• This FY saw CLIG drop its overhead assumptions within its dividend-cover template:

• Dropping the overhead assumptions raises suspicions of overheads continuing to increase. 

• CLIG admitted FY overheads (excluding certain items) in GBP advanced by 14%, but claimed they would not advance as much for FY 2024:

“Total overheads before profit share, EIP, share option charge and investments gains/(losses)* for the year to 30th June 2023 rose by 14% to £22.5 million (2022: £19.7 million), reflecting higher business development spending in comparison with the previous year, when Covid-related travel constraints limited outlays on marketing initiatives, together with ongoing investment in the Group’s IT infrastructure and inflation-related increases in payroll costs. Although cost inflation remains a concern, it is anticipated that the rate of growth in the Group’s cost base will moderate in the coming year.“ 

• I calculate those overheads climbed 3% in USD terms.

• CLIG’s largest overheads are employee salaries and the staff profit-share scheme.

• This FY indicated a 26.5% profit share (in GBP), versus 23.9% for FY 2022 and 22.2% for FY 2021:

• Did employees deserve a higher percentage profit share during this FY, which saw average FuM decline, average fee rates decline and profit decline? 

• I have never been sure whether CLIG’s profit-share scheme has actually incentivised the workforce to expand the business. 

• Between FYs 2015 and 2023, CLIG’s wages and salaries totalled $88m… and were enhanced 80% by aggregate profit-sharing payments of $70m.

• Yet the same nine-year period also witnessed a minimal aggregate inflow of net client money (see Funds under management: inflows and outflows):

• The last decade has not shown obvious (USD) revenue-per-employee productivity improvements either: 

• The average employee cost (including profit share) for this FY was $257k.

Financials

• CLIG remains a high-margin business, although not as high as it once was. 

• Operating profit before amortisation represented a super 39% of revenue during this FY. But I estimate the proportion fell from 40% during H1 to 37% during H2:

• The margin was 49% during FY 2021 and 46% during FY 2022 — supported by KIM’s super pre-merger 60% margin (point 8).

• The comparable FY suggested KIM’s margin was 54.5% (point 12c):

• The same small-print for this FY did not disclose a KIM margin:

• But the small-print did suggest KIM’s margin would decline further, with costs projected to grow faster than revenue:

“The annual growth rate used for extrapolating revenue forecasts was 1.5% and for direct costs was 3.0% based on the Group’s expectation of future growth of the [KIM] business.”

• Lower fee rates without commensurate FuM advances and/or reduced overheads will inevitably squeeze future margins.

• The text below is a regular fixture within CLIG’s annual reports:

“Keeping overheads down is good business practice as it provides more money for dividends, bonuses and reserves, and thus assists with relative job security.“

• Shareholders can only trust management will indeed maintain this “good business practice” to limit further margin declines.

• The balance sheet showed cash at $28.6m, investments at $10m and conventional bank debt of zero.

• FY interest on the cash was a handy $700k, with nearly $500k earned during H2.

• Cash conversion for this FY was once again very acceptable, with capex remaining low and working-capital management still very creditable:

(*Excluding intangible KIM-acquisition amortisation)

• Adjusted earnings of $21.4m translated into free cash after tax, capex, working-capital movements and lease payments of $21.9m.

• The $19.3m spent on dividends and a net $3.0m spent on shares for the Employee Benefit Trust (EBT) then left overall cash $0.5m lighter.

• CLIG’s EBT expense reflects the true cash cost of the employee share scheme and is worth monitoring.

• Between FYs 2019 and 2023,  the EBT spent $14.2m buying shares to satisfy exercised options and received $2.8m from those exercised options — equating to a net shareholder cost of $11.4m. 

• In contrast, the associated accounting charge during that same period was $5.4m.  

• Expensing the full EBT cash cost through the income statement would have reduced CLIG’s five-year aggregate $113m adjusted operating profit by 5%.

• The EBT purchased shares at an average 411p during this FY. Purchases subsequent to the year end were undertaken at 350p, 345p and 310p.

• Return on equity and similar ratios don’t seem relevant to CLIG. Earnings growth is driven inherently by attracting greater FuM, which in turn is not directly correlated to profit being retained as cash or reinvested into tangible items such as computers and office furniture.

• CLIG’s accounts remain free of defined-benefit pension obligations.

Valuation

• CLIG’s outlook perhaps optimistically cited a “foundation for growth“:

“Despite a challenging year, we believe the work done over the past twelve months has laid the foundation for growth. With a following wind, we are optimistic that the Group is well positioned to go further together given the complementary strengths of CLIM and KIM, attractive CEF discounts, and value in a number of asset classes managed by the Group.”

• This FY included a revised dividend-cover chart.

• The previous version had predicted earnings of £1.0m would be retained for FY 2024.

• But the new version now predicts £0.6m will be retained for FY 2024:

• The revised £0.6m is equivalent to 1p per share and, when added to the 33p per share dividend, implies FY 2024 earnings might now be 34p per share.

• I calculate CLIG’s rolling five-year dividend cover (in GBP) will be 1.24x by FY 2024 assuming:
  • Earnings of 34p per share for FY 2024, and;
  • The 33p per share dividend is maintained:

• CLIG’s 1.2x target dividend cover for rolling five-year periods — alongside the aforementioned $28.6m (c44p per share) cash position — ought to mean the 33p per share payout can be sustained during FY 2024.

• That said, the Q1 2024 (July-September 2023) update published during October was not encouraging:

• Q1 2024 FuM declined 6% to $8.9b, with clients withdrawing a net $152m and negative returns losing $391m.

• CLIG’s website then shows FuM sliding further to $8.5b during October:

• FuM at October’s $8.5b matches the post-KIM-merger low of October 2022 and is 16% less than the all-time high enjoyed at the end of FY 2021 ($11.4b).

• The Q1 2024 update disclosed CLIG’s first USD profit run-rate:

“The Group’s income currently accrues at a weighted average rate of approximately 70 basis points, net of third party commissions. “Fixed” costs are c.US$2.3 million per month, and accordingly the run‐rate for operating profit, before profit‐share is approximately c.US$3.4 million per month based upon current FuM. “

• $3.4m a month with a 26% profit share and 25% tax would give earnings of $22.6m or 44.6 US cents or 35.7p per share at GBP:USD 1.25

• Possible earnings of 34-36p per share and the trailing 33p per share dividend put the 320p shares on a multiple of approximately 9x and yield of 10%.

• Although CLIG has always traded on a modest rating, the present P/E and yield have been witnessed only a handful of times during the last 15 years:

• Future returns can be judged through CLIG’s (commendably public) total-return ambition, which is said to “stretch the management team“: 

“The goal of this KPI is for the total return (share price plus dividends) to compound annually in a range of 7.5% to 12.5% over a five-year period. This KPI is meant to stretch the management team, without incentivising managers to take undue levels of risk.” 

• The minimum 7.5% compound annual total return during the next five years appears very achievable, assuming of course the 33p per share dividend is sustained to support that 10% income.

• Should market conditions during the next five years return to those of FY 2021 — which saw FuM peak at $11.4b and the share price rally to 550p — then the compound gains from 320p will be much higher than the 7.5%-12.5% KPI range. 

• This FY confirmed the KPI was achieved for the five years ending FY 2023:

“Over the past five years, the average annualised return to shareholders is 8.0%, within the 7.5%-12.5% target range.“

• That five-year 8.0% annualised return was met almost entirely through dividends, as the share price at the start of FY 2019 was 402p and the share price at the end of FY 2023 was 404p.

• But will the KPI be achieved for the five years ending FY 2024?

• The starting share price for the five-year term ending FY 2024 is 406p, and to date dividends of 160.5p per share have been collected but the price has dropped 86p to 320p. 

• I calculate another 33p per share dividend and the share price recovering to at least 400p is required to meet the 7.5% CAGR goal for the five years to FY 2024.

• Therefore the KPI may indeed “stretch the management team” during the next year or so.

• The 320p share price was first seen during October 2007…

• …and the general lack of long-term capital appreciation does suggest CLIG’s operating economics, business strategy and/or management talent are not quite what they should be.

• I first bought CLIG during 2011 at 355p and the shares have since delivered a very generous income. Total payouts (ordinary and special) throughout the last twelve years have totalled 371p per share to recoup my initial investment.

• But this FY has heightened the danger of the handsome payout eventually becoming untenable as:
  • New clients remain very elusive;
  • Markets remain subdued;
  • Client returns remain very modest;
  • Client fees keep reducing, and;
  • Costs keep advancing.

• I wrote in my H1 2023 review:

“I do hope outside shareholders can rely on Mr Karpus — in his new role as “strategic advisor” — to provide frank views to the board on employee productivity.” 

• I am therefore pleased the increasing risk of a dividend cut has prompted KIM founder — and 31.5% CLIG shareholder — George Karpus into action.

• Mr Karpus issued a statement at October’s AGM and wants a fresh board:

“I believe this board should be replaced with a seasoned group of directors that understand the enormous potential of CLIG and that can guide the management in profitably growing the company.“

• I have spoken to Mr Karpus and this blog post recaps our conversation. 

Maynard Paton