We recently recommended Pinnacle Investment Management (ASX:PNI) as a buy, as there are a number of improving trends in the business. With the shares at one stage having gained nearly 10% since our recent report, do these factors support a further re-rating in the shares?
About Pinnacle Investment Management
PNI is a multi-affiliate investment management firm, holding equity interests in 16 boutique investment managers. The group provides boutique managers with distribution, infrastructure and support services, and holds minority equity interests (typically 23-49%) in the affiliated firms. The business model enables high calibre investment teams to establish a boutique firm via access to capital, institutional grade resources, and distribution.
The Company is well diversified in terms of its client base, the number of affiliates and asset class.
Key Fundamental Drivers
Performance Fees Are Contributing More to Profit
Since FY16, PNI has increased the contribution from performance fees as a portion of its total FUM from ~17% in FY19 to ~33% as at 1H21. There was a significant uplift in FY20 as five affiliates (Hyperion, Palisade, Coolabah, Metrics, and Firetrail) earned performance fees (including only the part-year period during which Coolabah was a Pinnacle Affiliate).
Higher performance fees are likely to become an increasingly significant contributor to profit and also means that the Company is less reliant on having to slow cost growth in order to support profit. The key factors underpinning the higher portion of performance fees include:
- Investment performance over the past 6- and 12- months for a number of PNI affiliate strategies is materially ahead of benchmark, thus supporting the outlook for performance fee revenue. As recent as 31 December 2019, there were a number of affiliates materially underperforming benchmark.
- In respect of institutional mandates, PNI pursue a deliberate strategy of favouring performance fee structures over ‘base fees only’ mandates, specifically in respect to capacity-constrained and/or high demand strategies.
Organic Fund Inflows Have Improved
Following deferrals in certain institutional allocations and lower net retail inflows as a result of COVID-19, net inflows recovered strongly in 1H21, across both retail and institutional channels. These fund flows, together with the rising market, increased 1H21 profitability in the Pinnacle Affiliates as well as in Pinnacle parent, where certain distribution fees are based on net inflows (in addition to regular base fees).
Recent trading updates have highlighted continued momentum in fund inflows, especially from institutional managers. Further, i) Fund inflows are widespread, as there is elevated interest in private credit (Metrics); specialty fixed income (Coolabah); global real estate (Resolution Capital); and domestic and global equities asset classes and ii) a number of affiliated have secured maiden institutional mandates as well as maiden international mandates.
Macro Environment Becoming Supportive
With a supportive macro backdrop for the Australian Funds Management industry (i.e. ultra-low interest rates, improving fund manager performance and positive equity market returns), PNI, with its diversified stable of fund manager affiliates, is well positioned to benefit. A key factor underpinning this view is that the portion & number of underperforming funds (to FUM) has reduced significantly over the last 18 months.
There are a number of PNI affiliates likely to benefit from this trend, supported by strong recent investment performance and ample capacity for growth. These include:
• Among PNI’s affiliates, Hyperion Asset Management has consistently generated the strongest excess return above benchmark, especially in the Hyperion Global Growth Companies Fund as well as the Australian Growth Companies Fund.
• There has been a strong turnaround in the performance of Firetrail over the last 12-18 months. As at 31 March 2021, the High Conviction Fund reported 1-year outperformance of +19% (compared to underperformance of -9.48% as at 31 October 2019) while the Absolute Return Fund reported 1-year outperformance of +54% (compared to underperformance of -5.5% as at 31 October 2019).
Balance Sheet Continues to Support Future Acquisitions
PNI has historically had a strong balance sheet position, which has supported: i) The Company’s strategy of acquiring affiliates, ii) Investment in growth activities, iii) Funding assistance for its affiliates (including by seeding new products) and iv) Dividend payments.
The balance sheet first utilised debt to acquire Coolabah in December 2019. Previously, the balance sheet was debt free. The Company targets at least two new affiliate firms per year and seeks acquisitions that enable a diversification in investment strategy, have a solid performance track record, possess highly scalable products and have a high portion of FUM subject to performance fees. As such, seeking acquisitions that meet these criteria means that acquisitions would not necessarily be immediately accretive to earnings. As an example, the Coolabah acquisition is expected to make only a minor contribution to earnings in FY21.
The shares are currently trading on a 1-year forward P/E multiple of ~26x. Notwithstanding the recent strength on the share price, this multiple appears attractive in the context of EPS growth of +34% over FY20-23 on a CAGR basis. Medium-term earnings growth continues to be supported by the maturing profile of existing affiliates and investment strategies and continued investment in new affiliates.
PNI shares broke under the uptrend line in early May. Since then they have got back above $10, which was major resistance. However, staying underneath this uptrend line is a concern and we might see a bit more sideways action in the short term. Once PNI is able to crack $11, then it should be able to continue trending higher again.
Michael Gable is managing director of Fairmont Equities.
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