Train, a star fund manager who has run the top-performing UK equity income investment trust since 2000, holds Hargreaves Lansdown (HL), the UK’s biggest funds supermarket; wealth manager Rathbone Brothers (RAT) and investment management group Schroders (SDR) in the £1.1 billion portfolio.
Shares in the first two have been under pressure in the past month after the City regulator confirmed plans to tackle high profit margins at fund managers and a lack of price competition and poor disclosure of charges in the sector.
Although the Financial Conduct Authority softened some of its previous criticism of active fund managers, its final report intensified the squeeze on active fund managers who have lost market share to low-cost tracker and exchange traded funds.
This does not alarm a bullish Train who says the competitive and regulatory pressures on investment fees have been clear for a long time. He says there are three reasons why they do not necessarily mean fund manager profit margins or even absolute levels of profits will fall.
‘Equity markets have a tendency to go up. Ad valorem fees [which levy a percentage of investors’ money] give fund managers leverage to this tendency and protect margins when costs are rising; technology change will lead to significant cost savings for fund management companies,’ he writes in his latest monthly commentary.
The issue for Train is not whether fund manager margins are under attack, but whether they have the growth to compensate and become winners of the future. He highlighted Schroders whose new chief executive Peter Harrison he said was ambitious to ‘re-engineer’ the business.
Train also believes history is on his side with all three stocks having achieved long-term dividend growth rates well ahead of their sector.
Schroders, which represents 6% of FGT, has grown its shareholder pay-outs by an annual compound rate of 14.5% since 1988, according to Train, with Rathbones and Hargreaves, a 6.1% position, generating growth rates of 11.4% and 23%, he said.
‘Since 1991 – as far back as Bloomberg will allow us to look – Schroders shares have increased 17-fold, Rathbones 21-fold, while the FTSE All-Share is up 3.5 times. Since its float in May 2007 Hargreaves has sextupled – the All-Share is up 17%,’ the fund manager said.
‘With historic margins of 60% for Hargreaves and around 30% for Rathbone and Schroders there is scope for narrowing of margins – if this is indeed to be required of the industry – that would still leave this trio much more profitable than the average quoted company in the FTSE All-Share,’ he added.
The powerful demographic forces of more people needing to save for their retirement underpinned long-term growth prospects for investment managers. Train concluded ‘it would take an industry-wide abolition of ad valorem fees to undo our expectation of continued superior economic returns,’ he said.
Judging from the FCA’s report, this is not on the cards as the watchdog challenged fund managers to tell investors what the all-in fee of their funds would be, not scrap the model of charging a percentage of their assets under management.
Last month’s sell-off provided a buying opportunity in all three stocks, Train said, disclosing the simple ratio of 'assets under management over embedded value' (AUM/EV) he used to compare investment groups.
‘At current prices Schroders sells at 1.5% of its AUM, Rathbone at 3.3% and Hargreaves 7.5%. These are well below recent valuations and further below what we would regard as full strategic value for the franchises,’ he said.
Over the past 10 years FGT has delivered a total shareholder return of 193%, putting it at the top of the AIC’s UK Equity Income sector where average growth among the 22 investment trusts has been 114%. It also beats the FTSE All-Share which has generated just 68%.
Its annual ongoing charges of 0.74% is in line with the average of equity funds but is slightly above the 0.69% average of its sector, according to the Association of Investment Companies (AIC).