If you listened to our weekly Companies and Markets podcast, you will have heard Phil Oakley and me discussing this at length. The short summary is that Hargreaves – and it is not alone – has made lots and lots of money doing very little other than arranging for their customers to buy and hold open-ended funds such as Neil Woodford’s ill-fated Equity Income Fund through its platform.
For this, it charges an annual percentage fee based on the amount of funds customers hold, a fee that, incidentally, it does not levy on other assets such as investments trusts, shares and ETFs. It is unsurprising, then, that its promotional efforts – like its Wealth 50 list – are often focused on encouraging customers to buy more funds, which now account for around half of the assets held by its customers.
The net result is that Hargreaves is very profitable, and getting more so all the time – its operating margins have widened from 41 per cent in 2007 to 65 per cent today. That’s because of something called operational gearing – it costs Hargreaves little more to administer £100m of funds than it does £10m, but obviously the fees it earns on £100m are much greater.
That’s a quality that, as investors in individual equities, we look for all the time, and a common characteristic of many of the world’s most successful companies, including Hargreaves Lansdown whose shares have returned a total of 1,187 per cent since it floated, hitting an all-time high of 2,447p just a month ago.
Since then, though, they have plunged by nearly a quarter, not because of the direct financial hit of waiving its fees on Woodford’s gated fund, but instead in reaction to the possibility that its customers will desert it as a result of the reputational damage caused by the fiasco.
I’m not so sure – given the levels of inertia prevalent among financial services customers I’d imagine that most won’t even have noticed the furore. But regulatory authorities have, and with that comes the risk that they will be exploring whether Hargreaves has crossed the line from an efficiently run and brilliantly marketed business to one taking more from its customers than regulators deem reasonable – a rent extractor, in other words.
Charges are the scourge of investors, significantly impacting returns over time. Many recent regulatory initiatives have focused on reducing them, and have been effective. Hargreaves has navigated these well so far, but it may be running out of road – especially if its competitors instigate a fee war. What is good for fund buyers may not be so good for its still highly rated shares.