Record — Evidence of new strategy gaining traction

We have updated our compilation of the information Record provides on AUME, fee income, clients and asset class exposure (Exhibit 1). This also includes our calculations of estimated average fee rates by strategy and hedging fee exposure by underlying asset class.

We highlight a number of points:

Starting with AUME, Exhibit 2 shows the progression of Record’s AUME levels and net flows from H121 (ending September 2020). During H122 overall AUME in US dollar terms increased by 5% to $84.1bn with net inflows of $1.9bn and positive market and other moves of $2.1bn. The net inflows included the launch of the Record Emerging Market Sustainable Finance Fund on 29 June in an exclusive strategic partnership with UBS Global Wealth Management. This earns a fee rate commensurate with an actively managed fixed income fund (50–60bp) and had a launch size of approximately $750m (included in currency for return AUME). The fund added a further $75m in Q222 with subsequent inflows taking its current AUME to nearly $1.2bn.

The 12-month increase in AUME was 28% or $18.2bn which included the build-up of a substantial dynamic hedging mandate which contributed to a $6.7bn inflow in that segment and total inflows of $11.9bn. Market and other moves added a further $6.3bn.

In sterling terms (not shown), AUME increased from £61.2bn to £62.4bn (2%) in the first half, with the average level increasing by 20% y-o-y and 9% sequentially (based on quarter end AUME figures).

The profit and loss account for H122 is set out in Exhibit 3. We comment on key areas below, with comparisons with H121 unless stated.

On product investment performance, Record reports that the continued provision of central bank liquidity to markets has meant that foreign exchange forward pricing has remained stable and that transaction costs have been low, limiting the opportunities for the enhanced passive hedging product to add value; over H122 a representative account recorded a negative return of 1bp relative to a fixed-tenor benchmark. However, since inception there was a positive return of 8bp per annum and, for comparison, the average fee rate in passive hedging is under 3bp. Fluctuations in exchange rates meant that dynamic hedging produced a marginally negative return reflecting costs generated by varying hedge ratios, but here again the since inception return remains positive at 43bp per annum.

Within currency for return products, the Record EM Sustainable Finance Fund (US dollar share class) had a negative return in H122 (-0.32%) but outperformed relevant indices such as the J.P. Morgan GBI EM Global Diversified Index (-3.56%). Finally, the multi-strategy product generated a positive return of 1.69% and a since inception return of 1.00%, with volatility of 3.13% per annum.

There is encouraging evidence of progress in the group’s strategy to increase growth, diversify and modernise.

Work on introducing new products in partnership with clients to meet their needs has started to bear fruit. The Record EM Sustainable Finance Fund has begun to make a significant revenue contribution with the full benefit to become evident in FY23. A Luxembourg-based municipal bond fund focused on the German institutional market is due to be launched in Q422 in partnership with Universal-Investment as management company (€710bn assets under administration). Record introduced an existing client, VTeam, to provide yield enhancement through European trade receivables financing. Record’s fixed income and derivatives teams will provide passive bond management. The fee rate is expected to be close to the estimated average fee rate given for dynamic hedging in Exhibit 1 of c 13bp. These products illustrate a move beyond Record being purely a currency manager and deploying its expertise to manage other assets and, in the process, earn higher fee rates. Further products are in the pipeline and other clients have also shown interest in the sustainable finance product (Record is free to address the institutional market). While the municipal bond fund has yet to launch, it and other products incorporating a yield uplift would appear to have a substantial market opportunity.

Talent development and management succession is underway with new appointments and promotions made in the last year. Incentives have also been provided to help motivate and ensure retention (90% in FY21 and an average of 85% in the prior four years). A joint share ownership plan was introduced in 2020 to help the next generation of management to acquire shares, option awards have been made, a commission scheme rewards contributions to new business acquisition and, as noted earlier, the group profit share payments have been set at the top of the target range. As we outline in the next section, increased costs arising from higher average renumeration is likely to increase personnel costs significantly in H222 and FY23: an investment to underpin the growth strategy.

The group continues with its technology modernisation process with projects that have included a new data warehouse and the introduction of third-party systems, on time and on budget. The internal IT team has been enlarged and specialist contractors are engaged to tackle elements of the programme as required. The investment will support new products, increase scalability and efficiency thereby enabling competitive offerings in lower-margin areas.

Other developments include additions to the European sales team in response to increased business and potential client interest. This year an application for a licence to BaFin has been made by the German subsidiary, which was established in November 2020.

Prospectively, Record reports that post-lockdowns clients have returned to considering new projects and that the themes of enhancing yield and sustainability are prominent for them. If crystallised in the form of mandates, this would validate Record’s known product initiatives while other products in development could provide further diversity by both category and geography. Meanwhile the existing core products in hedging remain stable with a generally long-term, large, institutional client base. The group underlines that it remains in transition and that there is still much more potential to deliver through its strategy. In the near term, increased costs (primarily personnel) are likely to moderate profit growth, but if revenue from new initiatives develops in line with or above our expectations (see below) then there is scope for good operational gearing.

There are four main drivers of change when looking at our estimates for FY22 and FY23 compared with FY21.

For the remaining elements of AUME we have not assumed any positive or negative net flows in our estimates. We have also assumed there are no performance fees over the forecast period. In practice the background for enhanced passive hedging mandates remains difficult and in the currency for return category the multi-strategy product still has some ground to catch up before earning performance fees.

As shown in Exhibit 4, our estimate for FY22 revenue is increased but higher assumed costs and tax rate result in a reduction in pre-tax profit and EPS estimates. For FY23, where we did not previously have published estimates, there is significant year-on-year growth in revenue, pre-tax profit and earnings (11%, 16% and 20% respectively).

Our dividend estimates shown above exclude special dividends. Following the shift in emphasis to ordinary dividends our FY22 estimate is increased by 65%. We pencil in special payments of 0.3p and 0.35p for this year and next, giving total dividends of 4.10p and 4.95p.

The group figure for net cash and money market instruments managed as cash at the half year-end was £17.3m (FY21: a comparable own cash figure of £16.2m after stripping out the non-controlling interest share of cash held by seed funds). The group capital position remains strong. At the end of FY21 Record had regulatory capital resources of £26.4m compared with a regulatory capital requirement of £9.4m. At end H122 tangible equity stood at £24.9m (after the FY21 final dividend and net share buy-backs totalling £5.7m but before payment of the interim dividend of c £3.4m). The introduction of new products is not expected to have a significant impact on Record’s capital requirement, which is calculated under a Pillar 2 risk-based approach (end-March Pillar 1 requirement was £4m).

Exhibit 5 shows an updated version of our comparative valuation table, with a selection of quoted UK fund managers. Following the price strength seen after the H122 results, Record shares trade at a premium to the average prospective, calendarised P/E and EV/EBITDA multiples, although the P/E premium narrows for calendar-year 2022 as our estimates begin to show the greater potential benefit of the new product introductions more than offsetting the increase in costs outlined above. On our estimates Record’s prospective yield (including special dividend) would be 4.5% for FY22 and 5.4% for FY23.