A powerful brand at a decade-low price

That said, higher interest rates haven't proved too painful either. Hargreaves Lansdown just enjoyed the most profitable year in its history thanks to higher interest rates generating record income on the cash and client deposits it holds.

As we push into 2024, however, the shares are 70 per cent below their 2019 highs, and the company faces tough questions over how it will sustain revenues once interest rates decline, and how it will see off rival platforms such as AJ Bell (AJB) and Interactive Investor, which is backed by the financial muscle of fund management giant Abrdn (ABDN).

Consumers are lazy

A large market share can be a blessing and a curse for companies. On the one hand, it implies a significant moat around the business and tends to generate plenty of investor interest, particularly when valuations are low. However, a large market share could also be a sign of incumbency, and possibly complacency. This could open up the field to competitors and the steady erosion of market position – something that investors are certainly alert to in the case of Hargreaves Lansdown. 

One thing that is clear from the problems challenger banks have faced in getting people to switch accounts, however, is that customer inertia is a powerful force.

Switching brokers is much easier than it was a few years ago, with investors able to make in-specie transfers – ie transfer investments in their current form – as easily as selling all holdings and then transferring the cash. HL does not charge an exit fee when a customer gives notice to move. Meanwhile, a regular complaint from seasoned retail investors is that the fees the company charges are high compared with more budget rivals, particularly for higher-value portfolios. A recent survey from UKstockbrokers.com, for example, reckons a £100,000 portfolio costs £450 a year to maintain.

This has not put off that many of the platform’s existing customers, however, with retention rates at 92 per cent. Brand loyalty is strong and HL is selling a premium service that includes add-ons such as advice, model portfolios and large amounts of (expensive to produce) education content. HL's customer base seems to need a compelling reason to move, rather than a host of incentives to stay. That's not to say there are no incentives, of course. The group has recently reduced the management charge for the lifetime individual savings account (Lisa) and removed charges completely for Junior Isas.

HL's market position is helped by the fact that certain companies are increasingly associated with certain niches. For instance, AJ Bell – which trades on a higher multiple than HL at the moment – specialises in pension drawdowns. Investors who trade shares regularly are likely to be more attracted by Interactive Investor's monthly flat fee, while hyperactive traders have any number of platforms to choose from. The point is that for investors who buy and hold, use a lot of funds and like to speak to a human being on the phone, HL is still the first choice.

Dynamic demographics

One interesting change over the past few years is that the customer base for HL, and the other platforms, is starting to change as demographics shift. Generation X and Millennial investors are slowly replacing cohorts of baby boomers. By the company’s own estimates, the average age of its client base had dropped from 54 in 2012 to 40 in 2021. The economic impact of this is significant. Firstly, a big proportion of clients is starting to draw down on their pensions and liquidate shares to fund their retirement, while at the same time a new group of investors is only just starting to build wealth through the platform. In other words, there is a value gap between the two groups.

According to analysts, it could be several years before the new client base becomes as profitable as the old one. But once in place, it should be ready for the tailored advice service that the company is currently developing. With its greater focus on the direct-to-consumer market (AJ Bell, by contrast, has a unique foothold in the advised market), HL needs the younger generations to be as avid a group of investors as the baby boomers were. There is a decent chance this will materialise, as an increasing proportion of its newer client base is starting to inherit valuable assets from their parents. In other words, the great liquidation of wealth accumulated in the past 40 years has only just started.

Hargreaves Lansdown has certainly been investing in technology to attract and retain these clients, and is embracing an "app first" approach. Technology costs have been rising for several years, and jumped by more than a third in the last full-year period. This strategy has been lambasted by the billionaire co-founder of Hargreaves Lansdown, however, and the investment is not yielding stellar results yet.

Fund management fees fell by 10 per cent to £54.3mn last year and platform fees edged down by 6 per cent to £271mn.

Paying for it all with cash

Perhaps a more pressing issue for HL’s shares, however, is the amount of interest the company currently earns on its clients’ money. Analysts at Jefferies believe that HL will generate around £270mn of cash in FY2024 from interest earned on deposits, relating to both clients and its own corporate funds. On its own, this covers the entire £225mn four-year investment budget for its improvement and transformation programme. Regulators are circulating, however.

The big unknown is whether the Financial Conduct Authority will substantially change the terms for clients with liquid cash balances held by investment platforms. Its investigation is focused on so-called “double-dipping”, whereby platforms charge twice, both on fees and interest, for holding the same pot of money for clients. HL has said that it doesn’t do this but regulatory intervention is a significant risk. On the other hand, its spending plans were designed without foreknowledge of last year's helpful interest rate boost, so the extra cash does not underpin the turnaround plans set out by the new chief executive.

The market has been pricing in both interest rate and regulatory risk for some time now and the shares currently trade on a 50 per cent discount to their long-term average, based on FactSet consensus forecasts. HL's forward price/earnings ratio sits at 11, while the group has a forecast dividend yield of over 6 per cent. The market, it seems, is waiting to see if the company’s self-help programme can pay off.

Hargreaves Lansdown has always been a powerful brand. The only difference is that it is now a powerful brand available at a decade-low price. While there are clearly macro, regulatory and competitive reasons for this, the lowly valuation still seems to belie an attractive and resilient UK large cap.