Odinian Beta

With the ASX 300 rising 25% over the past year, you’d think that fund managers – and firms like Pinnacle (ASX: PNI) that invest in them – had a very good 2021.

And you’d be correct.

Pinnacle, which holds minority stakes in 16 “Affiliates” (i.e. fund managers) such as Hyperion, Solaris, Antipodes and Spheria has had a fantastic 2021.

With funds managed (FUM) by its Affiliates rising 52% (on a 100% basis), to $89.4bn, over the past year, Affiliates’ revenue rose 43%, to $415.5m. A feature of this result was the dramatic rise in performance fees, up more than threefold to $86.2m, as a number of Affiliates outperformed their benchmarks.

As a result, Pinnacle’s share of its Affiliates’ net profit after tax (NPAT) rose 75%, to $66.4m. Although the parent company earns income from distribution fees and the like, it continues to invest ahead of future growth by expanding its team and so Pinnacle as a whole derives most of its earnings from its investments in Affiliates.

With diluted earnings per share (EPS) more than doubling, to 36.5c, shareholders have been rewarded by a doubling of the final dividend, to 17c per share.

Granted, it’s not Rio Tinto, but shareholders shouldn’t be complaining!

Leverage

Fund managers have a high degree of operating leverage. That is, once revenue covers their predominantly fixed costs of rent, computers, middle office and back-office staff and, most importantly of all, their highly paid portfolio managers and analysts, every incremental dollar of revenue earned mostly falls to the bottom line.

But an additional source of leverage is the movement in the stock market, as we have seen during 2021 and, in fact, ever since the market bottomed in March 2020.

As markets continued to recover during 2021 – the ASX 300 is up 24.7% and the MSCI World is up 37.2% over the past year – FUM for Pinnacle’s Affiliates has increased by far more.

This is because success tends to beget success in the funds management business: outperformance by Pinnacle’s Affiliates – 80% of Affiliates have beaten their benchmarks over 5-years – not only increases FUM in and of itself but attracts additional FUM as both institutional and retail investors pile into funds that are outperforming.

Helped by a healthy amount of operating leverage, the resulting 52% in FUM (on a 100% basis) has benefitted Affiliates’ profit and loss statements – in the form of both management fees and performance fees – and Pinnacle shareholders have in turn benefitted as noted above.

Ten-bagger

Management consistently describes Pinnacle as a “high growth company”, and its performance in recent years bears this out.

Over the five years to 30 Jun 2021, NPAT has increased at a compounded annual growth rate (CAGR) of 63.1%. EPS has increased at a slower but still very respectable CAGR of 36.5%.

Not surprisingly, Pinnacle’s share price has risen dramatically over this period, from $1.45 on 30 Jun 16 to $14.45 today. So Pinnacle has been a ten-bagger for anyone who was an investor in it 5 years ago.

Still a growth company?

“That’s all well and good”, you might say, “but what about the future?”

Well, future growth is likely to come from a number of sources. These include helping current Affiliates increase FUM via increasing distribution in international and listed markets, investing in new Affiliates, and further diversifying into other asset classes such as global equities, ESG, and private capital (debt and equity).

Pinnacle is also excited about exporting its model overseas, and will consider acquisitions should they meet its investment criteria.

Currently sporting a PER of 41, Pinnacle is expensive based on traditional metrics, with investors assuming that the company will continue to grow quickly in coming years.

Time will tell if they are correct.