The Business Of

Ninety One | What Are Their Costs?

Morning All!

So yesterday, we saw how Ninety One makes money. The company manages assets for clients (AUM) and charges an annual fee for their services (AMC). In 2022, Ninety One’s AUM was £144bn and their average AMC was 0.46%.

This gave Ninety One 2022 management fees (net revenue) of £633m (more than the £583m revenue for Man United we saw last week)… not bad!

Now, let’s move onto the costs required to operate their business model. So, without further ado!

Wait Hold On, Why Are We Even Paying 0.46%?!

Good question! Let’s go back. Because in order to understand an asset managers’ costs, it’s important to understand what value they offer their clients. So, what are pension funds and other clients paying asset managers for? Well, they need to grow their assets. But they could just do that by purchasing an ETF on a benchmark (e.g. S&P500 ETF). It would cost far less than the 0.46% annual fee that Ninety One charges. So why do they choose to pay asset managers instead of purchasing an ETF?

Well, the answer is outperformance. Asset managers are expected to create that magical thing called alpha and outperform benchmarks.

People + Process = Alpha? If Only…

So a mutual fund is always compared to a benchmark index. For example, a fund that is focused on buying only UK equities could use the FTSE100 index as a benchmark. If in a particular year, the FTSE100 goes up 5% but the fund goes up 8%, this would be outperformance of 3%. Good for the fund! However, if the fund went up only 1%, this would mean underperformance of 4%. Not so good! The reason these comparisons are important is because investors in the fund can see whether they should continue investing in the fund or as we mentioned earlier… just buy an ETF.

The graphic below shows a severe case of underperformance. The benchmark index went up ~25% over 5 years. However, the fund performance was only slightly above 0%. Meaning this fund underperformed by nearly 25%. Investors in this fund would have been much better off purchasing an ETF or investing elsewhere!

So what is it that really drives outperformance? Well, there are 2 main components: (i) People, and (ii) Process. Let’s use our previous example of a UK equity fund trying to outperform the FTSE100 to explore this. The fund picks 30 stocks in their portfolio.

It is the job of analysts and portfolio managers to find 30 companies from the 100 in the FTSE100 index that are likely to outperform the index as a whole. Exceptional people are able to analyse companies and find things that others aren’t expecting. This is ultimately what investors in mutual funds are paying for. They are paying for exceptional people to find them the best stocks and bonds. Some of the best portfolio managers in the world are compensated pretty handsomely for this talent…

However, it isn’t alllll down to exceptional people. Analysts and portfolio managers usually need help from some type of process. Most funds nowadays have quant analysts who produce algorithms that give analysts/portfolio managers ideas on which companies may be best to look at.

Saying that, process can also be a big barrier to outperformance. Many funds are constrained in how much they can diverge from the benchmark index. This is known as active share. Funds that require portfolio managers to take low active shares (to keep risk low) can really inhibit how much outperformance is possible.

The Promise of Alpha is Lucrative…

So as we’ve seen, the main thing clients are paying asset managers for is people. The talent of portfolio managers to pick the best stocks and/or bonds to outperform the markets. Because of this, it should hopefully come as no surprise that staff costs make up a huge proportion of Ninety One’s overall costs.

We should note that these staff costs aren’t all for star analysts and portfolio managers. Whilst they do take most of the praise, an asset management firm wouldn’t function without Operations, Sales, Marketing, HR, and other divisions too.

However, despite the strong investment in talent, outperformance has been very hard to come by! We’ll touch on this more in the ‘Outlook’ section on Friday!

Mamma Mia, Look At Those Margins!

Okay, let’s quickly touch on what COGS (cost of goods sold) and Other costs are for an asset manager. So the cost of goods sold for asset managers are commission expenses. These commission expenses are paid to investment platform providers - like Hargreaves Lansdown - that distribute the firm’s mutual funds.

Let’s use some visuals. In the screenshot below, you can see how Hargreaves Lansdown advertises Ninety One’s funds. When a retail investor invests in these funds through the Hargreaves platform, Ninety One will pay Hargreaves a fee (the commission expense) for their distribution efforts. However, these commission expenses (COGS) are incredibly low as a % of sales. Hence, Ninety One has a very strong gross margin of >80%.

Other costs reported on the income statement include expenses such as;

• accommodation (when sales personnel and portfolio managers need to travel),

• systems (e.g. Bloomberg terminals), and,

• information (e.g. sell-side reports).

All in all, despite the strong investment in employee talent, asset managers still boast remarkably strong and consistent margins as seen in the chart below.

In 2022, Ninety One’s EBIT margin was 31.7%. This is astonishingly high. And whilst these extremely high margin levels are something we see in most asset management companies across the industry… it’s incredibly uncommon in most other industries.

Remember, we’ve looked at 3 companies in previous weeks. Tesco had an 2022 EBIT margin of 4.2% whilst Deliveroo and Man United had negative margins due to both of them being unprofitable! As we continue to break down business models, it’ll become even more apparent how impressive margins are in the asset management industry!

15th Mar 2023

Nigel Jacob CFA