A wealth manager that's bafflingly underpriced

Brooks Macdonald (BRK) has been building a quietly effective business over the past few years as the asset manager and adviser has built up a loyal clientele in well-heeled towns. Investors have started to take notice, against a backdrop of consolidation and M&A in a fragmented sector whose largest players have struggled to grow, or where larger financial services groups see in wealth managers a lucrative new market and cross-selling opportunities. For Brooks, however, an emphasis on long-term relationships with clients and the distributors that push its services – rather than sheer scale – is showing a path towards greater profitability that others can follow.

One virtue of its relatively small scale, alongside its strong customer relationships, is that above-trend growth is possible. Having expanded more rapidly than peers since the start of 2022, the latest trading update saw funds under management (FUM) rise to £16.8bn in the first quarter of 2023, largely due to organic net new business growth of over 2 per cent.

This growth was down to both the company’s platform managed portfolio service (MPS), and within that its business-to-business division (BMIS), which broke the £1bn FUM mark for the first time. Like most MPS, the premise of BMIS is straightforward: Brooks offers a series of simple standardised white-label portfolios that advisers can use to manage client money on a discretionary basis. This allows them to hive off the management and administration of funds to Brooks and concentrate instead on client retention and recruitment. In a business where relationships are of critical importance, this helps to bind its distributors to Brooks for the long term.

Essentially, the business model relies on being able to grow organically, and inorganically, at a rate that is higher than the rest of the market, taking advantage of the trend for outsourced services among fund managers and distributors. Market volatility has only accelerated this dynamic as managers look to strip out all unnecessary costs from their operations.

Brooks has done a good job of smoothing its profits, too. Sitting somewhere between an outsourced service provider and a classic fund and wealth manager, it can charge fees for maintaining services in both good and bad times. And while the door to one-off performance fees is not shut entirely, it is less reliant on market performance to deliver earnings growth. Fundamentally, even if investors pull their cash from equity funds, they still need to park their money somewhere and Brooks earns fees from account administration whatever markets are doing. 

Given its scale, one key to Brooks hitting consensus earnings forecasts of 197p per share by FY2026 rests in its ability to fix its cost base. Apart from buying in growth through bolt-on acquisitions, the only way to achieve this is to improve the company’s operational efficiency. To that end it has a 10-year agreement in place with SS&C Technologies, a fund administrator, to update its IT infrastructure. A final £2.9mn slug of costs booked in relation to the contract in the last set of results shows this hasn’t come cheap, but more streamlined account administration raises the prospect of better operational gearing.

Overall, despite the capital spending, the company showed at its half-year results that its running costs were stable at £44mn, despite the impact of inflation on wages and basic services. Should this pattern shift, management has never been afraid to trim staff costs from the business.

A consolidating sector

Since the start of 2022, several wealth managers and brokers have disappeared into the arms of larger entities. First came Raymond James for Charles Stanley, followed by the acquisition of another pedigree brand, Brewin Dolphin by Royal Bank of Canada for £1.6bn. Recently, Rathbones (RAT) made a move for Investec’s wealth and investment division in an all-share deal. There has also been considerable movement in the unlisted sector as well, with Rathbones, Brooks and others all buying up specialist providers, particularly in the pensions planning segment.

The question for Brooks is how it chooses to pursue its “medium-term” ambition to become a “top five wealth manager in the UK and Crown Dependencies”. In addition to continuing to buy in growth, its options are to broaden into new products or markets or continue with an incremental approach of winning funds in a market underpinned by strong secular growth trends.

This doesn’t mean bigger is a better deal for shareholders. The paradox at the heart of the asset and wealth management industry, as investors in the sector are well aware, is that scale is no guarantee of growing profits. Indeed, while there is plenty of momentum behind Brooks’ business, its discounted market valuation might point to doubts about the source of its next leg of growth.

While acquisitions are always billed as earnings accretive for buyers, it is only with the benefit of hindsight (and months or years of tricky integration) when it can be said that a deal wasn’t in fact dilutive. Given valuations tend to get richer the larger the target (and more complex the deal), there is only a limited amount of consolidation that can take place before growth becomes harder to achieve.

This applies as much to the larger asset managers as it does mid-sized players such as Brooks and is an important consideration for any prospective investor who, having seen the sector’s mini flood of M&A, assumes it is a matter of when not if a much larger wealth or asset manager makes a bid. And while private equity interest cannot be ruled out, especially given the absence of debt on the company’s balance sheet – and the precedent set by deals such as Flexpoint Ford’s takeover of financial planning platform AFH Financial in 2021 – regulatory restrictions can always complicate matters.

The latter point is true regardless of bid activity. With the UK now outside of the EU, a further overhaul of industry regulation could be on the cards. In February, the Financial Conduct Authority published a paper setting out ideas for a new unified regulatory regime for all asset managers, whether institutional or smaller in scale. Though the watchdog is in listening mode, and merely calling for feedback, the prospect of another round of potentially disruptive changes might not be welcome for investors after their considerable spending on compliance reform in recent years.

Still, that challenge is not for Brooks to face alone. Given the company’s obvious qualities, it is curious that its valuation lags most of its less nimble peers and is only slightly ahead of Quilter (QLT), a firm that has endured operational upheaval and weaker new business flows. Analysts at Panmure Gordon point out that companies with less promising business models and weaker growth attract higher ratings, suggesting Brooks may suffer from a size-factor bias.

With a forward price/earnings (PE) rato of around 12, Brooks trades at a 30 per cent discount to the broader sector. That makes it an interestingly underpriced value proposition given its track record of growth and market position. If the changes it has made to its business processes start to generate operational gearing from next year onwards, the stock might soon start to look even cheaper.