Odinian Beta

After hovering around $56 in July, shares in fund manager Magellan Financial Group (ASX: MFG) have fallen to around $30 today after further turmoil at the group.

CEO Brett Cairns announced his surprise departure for “personal reasons” after the market closed on Monday.

I wont comment on Hamish Douglass’s personal life – it is none of my or anyone’s business – but unfortunately it isn’t helping in terms of sentiment either.

This is after the latest Funds Under Management (FUM) update showed that FUM rose 1.4%, to A$116.4bn, in November 2021. While this is a satisfactory result on the face of it, FUM was helped by the fall in the Aussie dollar against its US counterpart, with the little Aussie battler now buying 0.70905 US cents versus 0.75110 last month.

Source: Magellan

With the majority of the Magellan’s FUM invested in companies whose share prices are denominated in US dollars, it is likely FUM actually fell on a constant currency basis.

This is not really a big deal on a month-to-month basis, as FUM is going to move around based on the underlying performance of the firm’s various holdings as well as due to investor inflows and outflows.

However, what investors are really concerned about is the relative underperformance of Magellan’s funds versus their benchmarks. Possible dissension in the ranks leading to Cairns’s sudden departure – although this is purely hypothetical and speculation on my part – isn’t helping their nerves.

The flagship Magellan Global Fund (Open Class) fund has now underperformed by 14.5% versus its benchmark, the MSCI World Net Total Return Index (AUD), over the past year. The fund also now trails its benchmark over the past 3, 5 and 7 years.

Source: Magellan

The fund is still ahead over the last decade, albeit barely, but has outperformed its benchmark by a cool 3.71% since inception.

Investors are concerned that continued underperformance will lead to substantial outflows. With $86.2bn of the company’s total FUM of $116.4bn at 30 November 21 being from institutional investors, there is the risk that they create a stampede to exit and Magellan’s FUM plunges. (Retail investors tend to be far more “sticky” than institutional investors).

The real story

Yet just looking at relative underperformance doesn’t tell the real story. CIO Hamish Douglass has deliberately pursued a conservative strategy with an emphasis on downside protection and minimising the risk of permanent loss.

This strategy was behind his decision to hold additional cash coming out of the COVID-induced market plunges in March last year. Along with the benchmark soaring 26.6% over the past 12 months, this has made it difficult for Magellan, let alone any fund, to keep up.

Mistakes in the portfolio such as holding Ali Baba and Tencent despite Xi Jinping’s continued crackdown against rich Chinese and large Chinese corporations haven’t helped either.

However, all investors, even the best, make mistakes and so this isn’t a big deal either in my view.

The real test will be when the market corrects, as it inevitably will sooner or later. Here Magellan’s strategy has always paid off in maximising downside protection for its investors, and I expect nothing different in the next bear market.

With Douglass having managed the expectations of his institutional investors and with only 4 of its more than 130 Institutional investors representing more than 2% of management and service fees, the chances of a mass stampede for the exits are currently low in my view.

In addition, average FUM in 2022 is likely to be substantially above the $103.7bn average for 2021, thus leading to higher management fees in 2022.

As such, shareholders are looking at a dividend of between $1.80 and $2.00 before any performance fees. This puts the company on a yield of around 5.9% to 6.6%, albeit not fully franked, at current prices.

Shareholders also benefit from Magellan’s investments in Guzman y Gomez, Barrenjoey and FinClear, all of which appear to be well on their way to generating large returns, adding further downside protection to Magellan shares.

I guess it all comes down to whether investors think Hamish Douglass has lost his marbles. I have previously said I don’t think he has, and stand by my opinion on that score.