Rathbone growth on the cheap

Because of its manageable size, there is a distinct possibility that Rathbone could itself become a target for a larger predator. As things stand, Rathbones looks like it could be the most engaging investment prospect in the asset management industry – and one which isn’t guarded by a high rating for the shares

Two-speed growth

It's fast funds business, which accounted for 15 per cent of first half pre-tax profit, is growing at a rate that compares well with sector favourites such as Liontrust (LIO). Recent success is helped by the fact has a notable long-term presence in ESG investing, and the opportunity to grow earnings through relatively small incremental acquisitions.

In the first quarter, Rathbone's unit trust sales outdid bigger rivals such as Schroder's and Fidelity, according to the closely watched Pridham Report, which suggest the company is punching well above its weight; analysts have been upgrading forecasts for the year by an average of 11 per cent based on the greater level of fee income Rathbone’s expects to generate from fund management and sales.

The company's other, larger business, which offers investment advisory services, has struggled to build momentum over recent years. But things could be about to change. Rathbone has taken the conscious decision to grow by bolt-on acquisitions, rather than rely purely on organic growth to boost its long-term earnings. It recently completed the acquisition of advisory specialist Saunderson House for £150m, which was part funded by a £50m placing at 1,760p. It is biggest deal Rathbone has done in 4 years and one which added around £4.7bn of assets under management. The price paid is the equivalent of 3.2 per cent of AUM, which some analysts have queried as being high. But they also note that Saunderson with £85m per advisor, plus £2.2m per client is a high-end operation by the standards of the sector.

Whatever the merits of back-office consolidation, and the costs-savings that streamlining processes can bring, the deal’s main attraction is that it strengthens Rathbone’s presence in the profitable adviser niche. The deal not only more than triples the number of financial planners the company has on its books from 25 to 80, but it also gives it automatic access to Saunderson’s speciality in advising law and accountancy firms as well as high net-worth professionals. That is an important diversification at a time when robo-advisers, online-only trading apps and low-cost tracker fund supermarkets are splintering the retail investor market base and pushing long-term margins in the sector down.

The nature of the acquisition should also go some way to addressing the market’s traditional problem with Rathbone: that growth in the company’s advisory business remains modest compared with its direct competitor at St James’s Place (STJ), while Rathbone's smaller funds business that has experienced higher inflows from retail investors is not yet big enough to seriously move the needle for the group. 

Consolidation isn’t just a question of achieving cost-savings and better growth through scaling up. It also reflects the need to attract the attention of the distributors when it comes to matching funds and fund managers to the end investor. If a firm is too small, then the distributors simply won’t bother doing business with it and ultimately there is nothing to offer the client. It needs to be remembered that for Rathbone, growth comes from not chasing the mass-affluent - 56 per cent of its clients have assets of more than £1.5m and a fifth have over £10m.

The ESG imperative

Where Rathbone has an incremental advantage is its very long and established presence in the ethical, social and governance (ESG) area that is currently the single most important market trend in fund management. By long and established, we mean serious credentials – the original Rathbone family were part of a group of influential non-conformists who opposed the slave trade and campaigned for its abolition in the 18th century.

The modern business has supported ethical and charitable causes for much of its history and, arguably, ethical investors could buy the shares on their own on the basis that these are now an ESG proxy – in contrast to many other fund managers who have had to burnish, or simply invent their ESG credentials. Rathbone's ESG fund brand is less long-standing. Its Rathbone Greenbank global sustainability fund has only recently built a semi-meaningful track record of three years. Meanwhile, the Greenbank suite in March launched of four new multi-asset portfolios. Having a separate ESG unit within the group allows the manager more flexibility when it comes to managing the client-base – many of whom may not be purely interested in ESG investing.

Hunter becomes the hunted?

Although costs are expected to rise net year as Saunderson is integrated, higher fee income has pushed operating margins to 29 per cent and management is remains committed to an underlying long-term operating margin in the mid-20s. Achieving that level of operating margin would put Rathbone on a par with Schroders (SDR) which is seen by many investors as the gold-standard for the sector. On a reported basis, Rathbone still does well when compared with its peers and has average operating margin of 16 per cent, compared with just 4 per cent for St James’s Place. Given that there is limited ability to boost profitability through internal self-help measures – Rathbone is already a lean operation - a continued policy of bolt-on acquisitions is the most obvious route to take. But from this perspective, could a rival take the view Rathbone itself is an attractive prospect?

An investment manager can grow by buying client relationships, along with the technical expertise necessary to maintain both the consistent inflow of funds and their efficient management. In this respect, the quality of its client list makes it an obvious acquisition target for a much larger company or a merger candidate. For instance, speculation has been growing for a while that Jupiter Asset Management might need another merger to plug the consistent outflows from its funds and a similar sized company such as Rathbone might make the perfect match. While St James’ Place has currently pledged to cut back its plump costs and boost earnings internally, there is no guarantee that management has the staying power to do that, which is why it could eventually opt to add a quality investment sheen to its basic High Street appeal.

On a pure valuation basis, Rathbone scores well (see table). Based on the underlying quality of its business, the potential for the Saunderson acquisition to ignite advisory growth, and the growing importance of the fast-growing funds business, the discount to peers could narrow as the market re-evaluates prospect.