ÖKOWORLD — Profits and principles – a pioneer in SRI

Edison Investment Research provides qualitative research coverage on companies in the Deutsche Börse Scale segment in accordance with section 36 subsection 3 of the General Terms and Conditions of Deutsche Börse AG for the Regulated Unofficial Market (Freiverkehr) on Frankfurter Wertpapierbörse (as of 1 March 2017). Two to three research reports will be produced per year. Research reports do not contain Edison analyst financial forecasts.

Modern socially responsible investment (SRI) has its roots in the 1960s, when many political and social issues emerged after WW2. A rising number of investors realised that investments have impacts on both the fabric and consciousness of society. Investment capital can finance either socially desirable or socially destructive businesses. The trend gathered pace in the 1980s with events such as the Bhopal, Chernobyl and Exxon Valdez incidents. A sustainable and responsible approach to investing includes both quantitative and qualitative analysis. All investors look for profit potential, but responsible investors also integrate an evaluation of environment, social and governance (ESG) factors.

In the US, the “U.S. Sustainable, Responsible, and Impact Investing Trends” report screens the SRI market from the perspective of the investor. In the 17 years from the first Trends Report in 1995 and the most recent report in 2014, responsibly managed asset pools have grown from $639bn to over $6.57trn, an increase of 929% and a compound annual growth rate of 13.1%. SRI has become a major investment scheme (source: www.sriconference.com).

In 2006, the UN defined six major principles in its Principles for Responsible Investment (PRI) initiative; see: www.unpri.org/about/the-six-principles.

ÖWAG is a pioneer in bringing ethical and ecological financial solutions to the German market. It formed its principles early in the 1970s, refined them in the 1990s and has employed them since then. The company combines these ethical principles with the pursuit of sustainable returns. Over the years, the company has achieved a track record in operating successfully in the SRI market environment, both as fund manager and financial advisor.

ÖKOWORLD (ÖWAG) is the listed parent company of the ÖKOWORLD group of companies. On 20 December 2013 ÖWAG was born out of versiko, which the current CEO Alfred Platow and Klaus Odenthal founded in 1975. The name change reflected the growth of the Luxembourg-based fund subsidiary ÖKOWORLD Lux and the associated brand. The original insurance broker versiko offered a wide range of products, including pension schemes to sustainable companies. These schemes were offered through ökowerk e.V. ÖKOWORLD Lux SA was launched to provide the investment products for ökowerk and other clients.

Currently, in addition to the fund management and related activities, ÖWAG owns an insurance brokerage business – focused purely on pension schemes – and an asset advisory service for high net worth individuals (HNWIs), who have a strong SRI orientation. This business is executed by ÖWAG’s 100% holding in versiko ASS.

The parent company owns directly or indirectly 100% of each of its operating subsidiaries. ÖKOWORLD, the listed unit, additionally provides advisory services to its subsidiaries. ÖWAG’s shares have been listed on the SCALE segment as of March 2017. Given the size of the company, consolidated IFRS (or German GAAP) accounts are not required. For that reason, ÖWAG reports the results of the single listed parent/holding company. Hence, all income streams are the fees received by ÖWAG after costs incurred by the subsidiaries. Given the underlying growth of its core business streams, it is likely that ÖWAG will shift focus and start reporting fully consolidated accounts in due course.

The focus today is clearly on SRI driven fund management, executed by ÖKOWORLD Lux SA. Since 1996, it has launched six funds, which mostly cover global equity and are actively managed through a special stock-picking approach (see details further down).

SRI definitions are manifold in the financial industry, partly based on the UN PRI initiative. ÖWAG started early in defining its own principles. These are used across the firm, mainly as approval and rejection principles in the fund management arm. The stability of the SRI definitions helps the research team and the investment committee to implement them across the fund family, with success: over the years, the group’s AUM has increased steadily, providing a steady growth for fee income. ÖWAG provides its research exclusively for its own fund management group.

Comparing the growth in units in 2014 and 2015 with the growth in AUM indicates that ÖWAG’s increase in AUM was mainly a function of strong performance, in particular with the Classic and the Klima fund. A strong increase in net funds and performance was recorded for Growing Markets 2.0 and the multi asset ÖKOtrust Fund. All activities related to distribution are centralised in Hilden, the site of the parent company. Its products and services therefore are best described as ‘ambassadors of humanity’. As a parent/holding company, ÖWAG’s business model is based on fees, which are received as compensation for services to its subsidiaries.

Insurance brokerage (11% of 2015 revenues): Insurance brokerage is the historic business core of ÖWAG. The current range has an exclusive focus on pension schemes. This said, the income generation is mainly based on retention fees, a result of previous broader activities. As these contracts are based on long-term, annual contributions, ÖWAG should see a generally increasing income stream reflecting wage inflation. In 2016 management said that business increased by 20%, mainly in Q416, due to the new focus on individual and corporate pension schemes. This implies a new level of revenues around €1.6m as the basis for the following years.

Investment brokerage (1% of 2015 revenue): Investment brokerage is also part of the historic business core; here, ÖWAG sold third-party investment products to its clients. This business remains stable, as clients tend to continue investing with ÖWAG over a long period of time. The fees received by ÖWAG are essentially the retention fees of the investment brokerage and are therefore expected to grow steadily.

Performance fee (29% of 2015 revenue): The key earnings driver has been the performance fee: here, the company specific ‘one & only’ research approach, focusing on long-term, sustainable returns, resulted in a 65% increase in performance fees to €3.4m in 2015. Given the strong performance record, it is hoped that these fees will continue to grow. ÖWAG receives 45% of the performance fee, as the rest is kept within the fund management unit to cover its costs.

The performance fees are based on the quarterly high-water mark performance of the funds at the end of each quarter. The fee is based on absolute performance, given the structure and outline of the funds (see below). Fund management receives 10% of each increase in performance at the quarter end, assuming a positive performance against the previous high-water mark is achieved.

In 2016, ÖWAG received performance fee income on the total performance of the fund. However, against major indices, ÖWAG’s ÖKOWORLD Classic underperformed against key global indices.

Structuring and conception fee (47% of 2015 revenue): The largest income source is the segment ‘structuring & conception’; this segment is reasonably stable and accounted for annual revenue of €4.8-5.5m over the past five years. This represented 77% of revenues in 2012, compared to just under 50% in 2015.

Structuring fees are essentially basic retention fees, linked to the AUM of the fund management subsidiary. They are paid out on the base of the invested capital. ÖWAG’s fee structure is twofold:

As ÖWAG mainly distributes through third parties, 80% of these received fees (ie the 45%) are paid out in form of retention fees to these distributors representing just 36% of total retention fees earned by the fund management unit. In ÖWAG’s accounts, these payments to the distributors are shown as ‘material expenses’. The remainder is kept by ÖWAG.

Performance and management fees are based on the funds’ performance and retention of AUM. Here, ÖWAG’s main task is to market the success and the special SRI approach of the funds to retail distribution networks and institutions. More than 55,000 retail clients have been attracted through distribution platforms, namely:

Over the years, ÖWAG has developed an online approach with the help of ING DIBA (approximately €50m AUM) and Comdirect (approximately €40m AUM). The online channel is anticipated to boost fresh funds in the next years. The vast majority of AUM is held by retail clients, mainly (75%) in Germany. Of these, a focus is on doctors and medical service professionals, ie higher and stable income individuals. As they are not financially savvy, the distribution relies on the advisors’ ability to explain the ÖWAG funds and the desire of the clients to seek such SRI investments. ÖWAG’s funds are also held by institutions. These are mainly insurance companies, which distribute the funds. The company is not aware of any institution holding a significant amount, ie >€3m, in its shares.

ÖWAG’s business model is fee based and highly scalable: while revenues almost doubled in the period between 2011 and 2015, its personnel costs remained unchanged at €2m, while other costs only rose by 33%. As a result, net profit more than doubled to €3.4m in 2015.

ÖWAG’s success is dependent on the success of its fund management, as performance fees are the key income growth driver. The fund management is known for its strict focus on its investment principles; following recent scandals from non-compliance with SRI principles, many investors are realising that SRI actually is a protection factor from capital losses. Excluding performance fees, ÖWAG’s annual revenues hovered around €8.4m in the five-year period between 2011 and 2015.

The company’s latest newsflow on its operations, dated September 2016, reported a significant increase in business for the first six months of the year: net profits rose by more than 75% to €5.8m, clearly boosted by the strong performance of the fund business. While the company reported AUM of €716m as of 30 June 2015, a year later AUM had grown to around €800m, despite a difficult start to the year.

On 31 January 2017 ÖWAG reported further growth in AUM to €838m (+11% y-o-y) and also confirmed the positive trend in its insurance brokerage and advisory business, where revenues grew 20% in the year. By 20 February 2017, the company reported AUM of more than €900m, suggesting that the next target of €1bn AUM could be reached by H117. The company confirmed that 2016 had been a very successful year and said that it would be shown in a growth in net profit and dividend.

While ÖWAG is not required to issue consolidated accounts (neither under German GAAP nor under IFRS), it provided guidance for a ‘quasi’ consolidated income for 2016: consolidated net profits have reached €10.7m (after €3.3m income taxes).

ÖWAG is due to report final and detailed 2016 results in May 2017, coupled with the dividend proposal. Following the positive results in H116 and the reported continuation of business success in the run of the year, we assume these will reflect the success of ÖWAG’s two key business segments.

SRI investments have become more mainstream in the past 10 years. In 2006, the UN assisted the launch of six ‘Principles for Responsible Investing’. In the last 10 years, this initiative attracted 1,500 signatories with AUM of over $60trn. This trend simply shows that investors are becoming more aware of SRI and with this collective statement can influence companies to act accordingly. While in the late 1990s, just a handful of S&P500 companies issued sustainability reports, now some 80% are doing it (source: Barrons.com, 8 October 2016).

A main concern for a long period was that SRI excludes superior financial returns. However, according to PricewaterhouseCoopers, “the empirical evidence is clear: by investing responsibly the suggestion is that there is no sacrifice in financial return, on the contrary, recent research shows that long-term financial returns are less volatile and above average. Evidence is delivered by two meta-studies, one conducted by Mercer and one by Deutsche Bank” (source: PwC Switzerland Responsible investing: from a niche strategy to a global trend, 2015). The Deutsche Bank study of 100 global investment cases states hat environment social governance-orientated companies “are more stable in value and less prone to crises. They correlate with superior risk-adjusted returns at a securities level” (source: PwC).

ÖWAG invests globally, but its funds are chiefly distributed in Germany. By the end of Q316, 409 SRI funds with aggregated AUM of €65bn (400 funds with €45bn by the end of 2015) were registered for distribution in Germany (source: www.nachhaltiges-investment.org/News/
Marktberichte.aspx). Of these, there were 217 funds with AUM of €33bn invested in equities (ie on average €150m/fund), 86 funds with AUM of €13bn in bonds and 74 funds with €13bn in multi-assets. Nineteen SRI ETFs with AUM of €2.5bn complete the list.

ÖWAG’s funds currently have about €1bn AUM, ie they represent 1.5% of the overall German SRI market, but about 3% of the equities investment market, where ÖWAG is mainly present. With more than €550m AUM, its flagship fund ‘ÖKOWORLD Classic’ is about four times the average fund size. In terms of return (>70%) over five years (through to July 2016), ÖWAG’s Classic fund had outperformed its main competitor funds of JSS, Pioneer, Swisscanto, Carmignac, DJE, DWS and M&G, while showing low volatility of 14% (over 260 weeks).

Currently, in SRI, ETFs are less of a competitive force and active management maintains a strong position.

While the number of SRI funds is increasing, ÖWAG maintains its top rankings even among the increased competition. ÖKOWORLD compares its performance against a selected peer group, mainly over a period of five years. Here, ÖKOWORLD Classic showed an annual average performance of 12.7% (after costs) as of 10 January 2017, beating its main rivals Swisscanto Green Equities, JSS OEKOSAR EQ-P, ÖWAG-Aktienfonds, Pioneer Funds Global Ecology-A€AC and Spängler IQAM EC ST-A.

The management consists of Alfred Platow and Michael Duesberg. While Platow is a German SRI pioneer, who started the business in 1975, Duesberg is an IT specialist and fund manager by training. Together they combine the qualities required to run a slim and streamlined operation.

ÖWAG’s key income source is asset management fee income. Therefore, we have looked at the fund management process in more detail, as it employs a special ‘selection’ tool through an independent advisory board.

The investment management team at ÖKOWORLD Lux SA selects its investments out of the investable pool of companies, pre-selected by the research board and vetted by the investment committee with the help of the scientific support board. The ‘qualitative’ selection under the company’s own SRI principles has already been done and therefore the investment management can focus purely on the financial performance. This structure allows ÖWAG to market and promote funds that consistently rank among the top performing funds in the industry.

To illustrate the work of the group, we look at ÖWAG’s flagship fund ÖKOWORLD ÖKOVISION Classic.

ÖKOWORLD fund management employs a stock-picking approach. This drives the performance fee income, which is not based on relative performance against an index but on absolute performance. The investment universe is global and covers a broad market cap spectrum. ÖKOWORLD fund management invests according to several criteria, which are difficult to cluster into ‘value’ or ‘growth’ categories. The fund management aims to identify stocks that achieve earnings even in specific market conditions, such as rising energy costs. Hence energy efficiency is an important criterion. In a recent study conducted by the South Pole Group of Switzerland, stocks in the ÖKOWORLD Classic fund exhibited a 73% better CO2 emission than the MSCI World Index. Other criteria include companies with unidentified growth potential in ecological areas.

The company’s equity is divided into two share classes: 4.20m voting shares (not listed) and 3.95m preference shares (listed). ÖWAG’s ordinary shares are held primarily (75%) by the founders of the company, CEO Platow and the co-founder Odenthal. All other ordinary shares were held by employees, but family splits and departures led to 5% of these shares now being held by non-employees. All preference shares are free float, mainly held by clients (both of the fund and the insurance business segment).They are entitled to dividends. ÖWAG can track these, as its shares are ‘Namesaktien’, ie registered shares. Of these, some shares are held by the distributing insurance companies. Around 10% of the preference shares are treasury stock, which was bought back by the company in previous years. These shares are not entitled to dividends.

Given the fact that the ordinary shares are not listed and the company holds around 408,000 preference shares as treasury stock, the actual free float is 43% of total shares in issue.

ÖWAG is essentially an asset light fund distributor with most of its revenues originated directly or indirectly from the owned fund business in the forms of fees. This income is sustainable in so far that the funds consistently rank among top performers, generating performance fee income in addition to management fees. However performance fees can be impacted by near term general market conditions.

The four-year revenue CAGR shows an annual 12% growth, coupled with a 32% PBT growth rate: a sign of healthy economies of scale at work. EPS growth was 23% in the same period, leading to a 14% CAGR of dividends. The latter is explained by the fact that ÖWAG paid out 200% of EPS as dividends in 2011, the base year for the CAGR calculation.

ÖWAG’s business model is based on strong cash generation in order to provide sustainable dividends and dividend growth. Over the past five years, its net profit margin grew to reach levels between 25% and 32%, while ROE more than doubled from 11.6% in 2011 to almost 25% in 2015. Key drivers were the strong performance fee income and strict cost management. ÖWAG’s personnel costs remained basically unchanged throughout the five-year period. The profit evolution is best characterised by the ROE progression: since 2011, ROE has grown fivefold to c.25%.

ÖWAG’s net debt stood at around the €3.5m mark for most of the last five years, but turned into net cash of €828k in 2015. The main reason was the disposal of non-core businesses and a reduction of receivables. In addition, due to HGB accounting, there has been no valuation adjustment of its financial holdings, namely the ÖKOWORLD Lux SA. The holdings in associated companies remained at €7.1m. Assuming a 3-5% value of the AUM managed by the fund, a potential fair value might be in the range of €30-45m. While profits grew substantially, the generous dividend policy left total equity almost unchanged at €13.8m.

On the cash flow side, ÖWAG distributes the majority of its annual cash flow in the form of dividends. After the 2014 dividend payment, the company’s current cash reserves are sufficient to grant cover one future year’s dividend payment.

ÖWAG focuses on long-term performance for its shareholders. A Reuters analysis confirms this approach. ÖWAG’s five-year ROA is threefold the industry average, and its five-year ROI more than twofold. Although its dividend yield beats the industry and the sector, the five-year dividend growth rate is also superior to that of the industry.

Historically, ÖWAG has traded at P/E ratios between 13x and 17x, which appears to be around market average. However, its dividend yield is far superior to the 10-year SDAX arithmetic average of 2.4%. Given the strong net profit CAGR of 22%, well above the market average, a certain premium to the average market valuation appears to be justifiable. ÖWAG continues to provide a strong dividend stream to its shareholders.

A peer group valuation appears to be difficult, as directly comparable business models are not seen in the market. In most cases, the asset management units are not listed, while the funds are listed and trade around NAV.

Companies with both business structures might include Patrizia Immobilien (real estate asset management in separate funds, asset structuring and advisory); MLP (an insurance broker and asset advisory, running its own fund group); IMPAX Asset Management (managing and advising on approximately US$6.8bn primarily for institutional clients); and AZIMUT asset management (specialised in asset management, the group offers financial advisory services for investors, primarily through its advisor networks).

ÖWAG is essentially a fund management company (in terms of fee income, while the funds are managed by a 100% subsidiary) and an insurance brokerage firm. Its income stream therefore depends on the performance of its fund management and the stability of the economy. Key sensitivities include:

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