Polar Capital surfs the fund flow waves

Free the numbers of any context, and the 12-month period to 31 March 2021 was pretty flattering for financial markets. It started with the MSCI All-World Index in a trough at $426 (£309) and finished with the global equity benchmark up 60 per cent at $680.47, an all-time high.

Plot it on a chart and the profound economic uncertainty that marked much of that time is barely detectable.

For asset managers, such rare periods of one-directional mania are usually a welcome boost to performance fees. The effect is doubly powerful when it is accompanied by fevered stock-buying. But for active funds with designs on outperformance, equity markets' post-crash rally has also set punishingly high expectations for the coming years.

Full-year figures for Polar Capital (POLR), well-known among retail investors for its Technology and Global Healthcare trusts, bear this out. At the beginning of the year, the value of the company's assets under management (AuM) was £12.2bn; 52 weeks later, the pile was 71 per cent higher at £20.9bn.

Average AuM for the year – up 18 per cent to £16.7bn – paints a more measured picture, but still reflects impressive net inflows of £2.1bn for the period. The acquisition of boutique UK asset manager Dalton and two value-focused fund teams from Los Angeles-based First Pacific Advisors, added another £1.7bn.

Canny deal structuring – in the form of a revenue-share agreement with First Pacific and a cash-and-deferred consideration split for the Dalton team – meant Polar could massively expand its team footprint with barely a scratch to the balance sheet. Management has capitalised £25.4m-worth of goodwill following the deals, while net cash has risen by more than a quarter.

This was despite a 31 per cent bump in total operating costs, which hit £118.5m in the period owing mainly to the increase in headcount, but also because of investments in operational support and distribution.

Beyond soaring asset values and strong fund performance (more on this later), it is the latter front that investors should be most pleased with. In the past year, the group has added open-ended fund structures in both Western Europe and the US, vastly expanding the range of investors who can buy into Polar's funds.

According to chief executive Gavin Rochussen, this has helped to tap into two big sources of international client flows: Asian investors looking to buy into global thematic funds and US investors looking for exposure to (often cheaper) non-US equity markets.

Half the funds

Indeed, for US stock buyers – still the largest pool of equity market liquidity in the world – the signature attraction of Polar's brand is never going to be the Polar Capital Technology trust. After all, the chief investor audience for the technology team – which now manages £10.2bn – has fewer options to match the performance of the Dow Jones Global Technology total return index.

Polar's success in this endeavour – on a three, five and 10-year view – has been a major contributor to its brand cache. Breaking free of a heavy concentration toward technology and healthcare is nonetheless proving a challenge.

Rocussen points to the success of the UK value, financials and emerging market teams since the vaccine-sparked rotation to value as evidence that Polar's broadening stable can benefit from several different asset allocation strategies. But technology still grew its share of the total asset pile in the year, from 43 to 49 per cent.

"The harder we run the harder we have to run," concedes Rochussen. "All of these positive diversification flows are still battling to keep up with technology."

Alongside investors' continued pivot to value and financial stocks, one potential route out of this conundrum arrives in September, in the shape of a sustainable investing team from Robeco Switzerland. The group, which manages over €5bn (£4.3bn), will launch strategies focused on two already very popular themes: clean energy and electric vehicles.

Some may conclude this simply adds exposure to sectors where valuations are already sky high. Others will view these kinds of funds as must-haves and good opportunities to cross-sell. Polar's mantra, says Rochussen, is single-minded: provide a product that beats the benchmark.

Cheap for a reason?

FactSet-compiled consensus forecasts are for earnings of 64.4p and 73.7p per share for FY2022 and FY2023 , respectively, meaning the shares trade at a slight discount to the broader asset management sector.

One effect of this has been to push Polar's forecast dividend yield up to 5 per cent, which seems a little harsh given the evident growth opportunities and the strong brand name. For comparison, near-term income prospects at other well-regarded UK active managers Liontrust (LIO) and Impax (IPX) look much weaker, despite their concentration in certain growth-focused sectors.

We reckon this caution is a function of two investor concerns: that Polar's huge weighting to red-hot growth stocks could suffer in a higher interest rate environment, and that diversification efforts to balance the portfolio will lead to a mean-reversion in performance.

While the latter dynamic should never be discounted, it risks a misunderstanding of Polar's business model, which is predicated on offering a range of specialist thematic funds. Neither its scale nor its focus put it in competition with the passive giants, which broker Numis rightly describes as a "race to the bottom for an active manager".

With a good brand and strengthening distribution channels, the shares still look undervalued on a cash-adjusted forward earnings multiple of 11. Since the year began, another £517m of client money has flowed in.

The people-centred nature of asset management means this is one highly cash-generative UK company that is unlikely to succumb to private equity interest. Were a bid to come from within the sector, we expect it would need to be at a massive premium. Buy.

Last IC View: Buy, 606p, 19 Nov 2020