Have Magellan and Hamish Douglass lost their marbles?
From a standing start in 2006 – not the best timing given the onset of the GFC! – Hamish Douglass has built a funds management colossus at Magellan Funds Management (ASX: MFG).
The firm now manages around $118bn, with $86bn in institutional mandates and $32bn in retail funds under management (FUM). Most of the FUM is invested in Global equities, with $19.8bn in Infrastructure and $9.6bn in Aussie equities.
Magellan has also recently started a retirement-focussed product called FuturePay and is also expanding its ESG / sustainable investing offerings.
In recent years the firm has also diversified into taking investments in other companies, with the most notable being a $156m investment in investment bank Barrenjoey and a $103m investment in Mexican fast-food outlet Guzman y Gomez.
Investment strategy
Magellan pursues a strategy of investing in quality companies that have strong market positions and which are able to reinvest their retained earnings at high incremental rates of return. Some of the flagship global fund’s current holdings include Visa, Facebook and Microsoft.
However, Magellan shares have underperformed the market since the March 2020 pandemic lows, being approximately where they were 18 months ago.
Investors appear to be concerned with the firm’s recent underperformance – the flagship Global Fund (Open Class) now trails its benchmark by 1.06% per year over the past five years. The underperformance over the past year is even worse, at 18.82%.
This compares to the fund’s outperformance of 4.02% per year since fund inception.
The underperformance is due to Douglass adopting a cautious stance coming out of the market plunge caused by the pandemic, holding elevated levels of cash as the market continued its strong returns since then.
Another concern of investors is that growth is going to be harder to come by now that FUM is around $120bn. On the face of it, this concern is somewhat warranted. Obviously it is harder to double FUM from a starting level of $110bn than it is starting with $10bn or even $1bn in FUM.
Worries overblown
Yet I think these worries are overblown.
Every fund manager has a period of underperformance, particularly those like Douglass that are willing to be contrarian rather than investing in whatever the market is currently excited about.
With Magellan’s global equities portfolio invested in high quality companies that still have significant growth runways ahead, I think it is only a matter of time before Magellan again outperforms.
As to growth worries, there is some merit to this, but the firm is still launching new strategies, with material growth still available in its newly launched retirement product FuturePay in particular.
Diversification
What I think the market is overlooking is that Douglass appears to be deliberately following a strategy similar to Warren Buffett after his takeover of Berkshire Hathaway. This was actually a mistake by Buffett due to the poor prospects for textiles but he used Berkshire Hathaway’s free cash to invest in better businesses.
Most investors would agree that this has been somewhat of a success over the past 60 years!
I think Douglass is following a similar strategy as growth in Magellan’s main funds management business slows. This explains the investment in Barrenjoey, Guzman y Gomez and FinClear.
The market is particularly concerned about Barrenjoey given it has cost a fortune to set up. Investment bankers don’t come cheap – after all, they have expensive cars to buy and second and third houses to maintain! Yet given the people it has hired and the networks they have, I wouldn’t be surprised to see it become a mini-Macquarie in due course.
I think it is likely that Douglass will continue to use Magellan’s surplus cash to invest in other companies to further diversify Magellan’s earnings in coming years.
And based on its current FUM and assuming NIL performance fees, the business is selling for a yield in excess of 5%.
All in all, I don’t think Magellan shareholders should worry that Douglass has lost his marbles. I think he has a few tricks up his sleeve yet.
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