Record — Potential for further positive surprises

The company was founded in 1983 by the chairman, Neil Record and listed on the London Stock Exchange Main Market in 2007. With offices in Windsor, UK (head office), New York and Zurich there are 84 employees, including 60 investment professionals. The group’s main activity is the provision of currency hedging services acting as an agent for clients, including public and private defined benefit pension schemes and other institutional investors. Record also offers currency for return, multi-product and related services.

In FY19, passive hedging accounted for 52% of management fees. While there were outflows during the year, passive hedging mandates tend to be sticky and we estimate that revenues from these clients will cover over 80% of Record’s operating expenditure before variable remuneration in the current year. Record competes with large banks in providing passive hedging but underlines its independence and its ability to tailor a mandate to customer requirements and may include additional services such as collateral and tenor management. Dynamic hedging also targets systematic reduction of currency risk while seeking to modify the level of hedging to allow clients to gain some benefit from weakness in their own currency. Currency for return strategies aim to exploit stable inefficiencies in currency markets. They include: forward rate bias, emerging market currencies, momentum, value and, relatively recently introduced, range trading (together ‘multi-strategy’). Multi-product includes mandates where hedging and return-seeking strategies are combined on a bespoke basis.

Exhibit 1 below provides an analysis of Record’s AUME, management fees and client profile.

The first section of the table underlines the predominance of hedging for both AUME and fees (73%), despite the relatively low fee rate applied in passive hedging. The client analysis shows that the number of clients has increased noticeably since 2014. Record counts each legal entity as a separate client but in some cases there will be one commercial relationship covering a number of entities which can mean lumpy increases or reductions in the client count. The institutional nature of the market Record is addressing means there is quite a high concentration of fees from the top 10 clients (71%). Over 20% of clients have been with the firm for over 10 years and 40% for more than six years. The geographical analysis highlights the importance of Switzerland as a market (primarily for hedging services).The progression of AUME in recent years has been dampened by the $4.6bn outflow from passive hedging mandates seen last year but inflows in 2015 and 2017 together with market, FX and other moves have allowed the total to increase over the period shown. Finally, the analysis of the exposure of the dynamic and passive hedging mandates to different underlying asset classes shows that, on our estimate, around 46% of hedging fees are related to equity assets and 32% to fixed income assets.

Exhibit 2 provides an analysis of AUME movements and the related management fees for FY19. As noted above, the main feature within flows was the $4.6bn of passive hedging outflow. This included $2.5bn related to two commercial relationships where specific developments including moving to a unitised structure prompted the terminations. Otherwise, the dynamic hedging outflow included a $1.1bn reduction arising from discretionary profit-taking undertaken by Record for a client with the potential for the hedging position to be re-established in due course, subject to exchange rate movements. The outflow in dynamic hedging was more than balanced by inflows for currency for return. Positive market moves and negative FX and scaling changes (for mandates with a volatility target) were broadly balanced. The net result was an 8% reduction in period-end AUME and a 1.5% reduction in average AUME.

These moves and the associated mix changes fed through to a 6% reduction in management fees in US$ terms or 5% in sterling terms, as shown below. Record reports that average management fees were broadly constant for most products during the year, although mix changes between product groups and by clients within groups has influenced the overall average fee rate; on our calculation it has moved from 5.1% to 4.9%. Changes included the addition of a new currency for return client on a management and performance fee structure with another moving to a more bespoke service: both reduced the average fee rate. Within passive hedging, further clients of the enhanced passive hedging service opted for a fee structure including the potential for performance fees.

Exhibit 3 shows the profit and loss progression between FY18 and FY19. Reflecting the AUME changes described, total management fees were 5% lower but performance fees of £2.3m were earned allowing revenue growth of nearly 5%. Record had previously indicated that management fees would be reduced by c £1.2m by the introduction of fee structures capable of earning performance fees so the fees earned in the year more than compensated for the lower management fee rate involved in these mandates.

The group continues to apply cost discipline with operating costs before variable remuneration flat at £13.3m or up 3% excluding the cost of the tender offer in FY18. Overall staff costs were up 4.6% mainly reflecting the increase in the average headcount from 81 to 85. The staff additions have been made to support client service and innovation. Total administrative costs as shown in the table below were up less than 2% allowing pre-tax profit and diluted earnings per share to increase by 9%.

The ordinary full year dividend of 2.30p was unchanged while a special dividend of 0.69p gave a total of 2.99p. The special dividend was set to distribute all earnings after allowing for capital retention of 0.28p per share to maintain a level of capital in line with the group policy (see comments on the financial position in the next section).

Record provides product investment performance information with its results. Since H119 this has included figures showing the performance of its enhanced passive hedging strategy measured relative to a fixed-tenor benchmark (the strategy seeks to add value through tenor selection and timing). The strategy added 3bp in the first half and 5bp for the 12-month period. Since inception the outperformance was 12bp.

Exhibit 4 shows performance figures for the FTSE FRB 10 Index, emerging market and multi-strategy funds. While the emerging market and multi-strategy funds show negative returns over the 12-month period, a recovery in emerging markets currencies means that the returns were significantly less negative than was the case at the half-year stage.

While currency volatility between the euro, US dollar and Swiss franc has subsided compared with earlier years (Exhibit 5) geopolitical uncertainties, including trade negotiations between the US and China and tensions within the EU, are among factors that are likely to be contributing to the broad interest Record reports spread across its product range and geographically. The strengthening of the US dollar (Exhibit 6) does not appear so far to have generated the cyclical increase in interest in hedging services that might have been seen previously. However, Record’s own work on improving client service (more staff are being added in the New York office) and product innovation is contributing to the retention of clients and interest on the part of potential clients.

Record has consistently cited the need to be innovative in enhancing existing and developing new products in order to counter competitive pressures and client expectations of a downward trend in fees (reinforced by the prevailing pressure on asset manager fees). Developments in the currency markets linked to capital constraints for bank participants, emergence of non-bank liquidity providers and algo trading create both challenges and opportunities for a specialist such as Record. Newer products include enhanced passive hedging, a range trading strategy within currency for return and an ESG (environmental, social and governance) overlay. Additional services offered could become more significant although at this stage the scope for development is not clear. They include collateral and cash management, spot execution, equitisation and audit of FX execution.

Headline figures from our revised estimates with a newly introduced FY21 forecast are shown in Exhibit 7. The small increase in our FY20 revenue estimate reflects a combination of a more favourable sterling US dollar rate and factoring in a slightly higher management fee rate than we assumed previously, based on the H219 run rate. The decline in revenue between FY19 and FY20e reflects a lower level of average AUME as we do not assume any inflows and the fact that we do not include any performance fees in our estimates until reported. Performance fees or positive flows could therefore provide upside to our numbers. With our cost assumption little changed the increase in our revenue estimate feeds through to 4% and 5% increases in our pre-tax profit and earnings per share estimates, respectively. Record indicates that it will in future apply its group profit share scheme with closer linkage to individual performance. The overall level has historically been set at 30% of pre-profit share operating profit within a formal range of 25% to 35%. In future the revised operation of the scheme may result in variation within this range but our modelling assumption has been kept at 30%.

It remains the board’s policy to retain sufficient capital (effectively equivalent to shareholders’ funds) to at least meet the regulatory requirement plus 12 months of operating expenses (less variable compensation), working capital requirements and capital required to finance new business opportunities. Shareholders’ funds were £27.3m at end FY19 and deducting proposed dividends of £3.6m, intangible assets of £0.3m, and the £9.3m regulatory requirement, would leave a balance sheet cushion of £14.1m of which £4.3m is currently allocated to seed funds. This cushion provides confidence to Record’s clients and potential clients.

Liquidity also remains strong with no debt and cash and cash equivalents at the year-end of £23.7m, or £17.9m excluding cash held in seed funds (£17.2m end FY18).

We start with a table showing Record’s recent price performance in the context of the UK asset managers that we use as a basis for valuation comparison. This highlights two things: the recent, post-results strength that has meant that Record shares have outperformed the peer average over one and three months and, secondly, the shares have still underperformed the average over one year, year to date and from the 12-month high.

As shown in Exhibit 9 (the table shows 2019 multiples on a calendarised basis), even after the recent share price strength Record trades below the peer group averages on P/E and EV/EBITDA multiples. The dividend based on the ordinary dividend alone is above average at 6.8%. It should be remembered here that our EPS estimates exclude any potential performance fee earnings while, if earned, performance fees could also contribute to the total dividend payout (our estimates currently assume only ordinary payments).