GQG Partners: A Stock Unrightfully Punished by the Magellan Storm

 Executive Summary

• Founder-led asset manager with a strong performance history and lowest quartile fee among global peers.
• Capital-light compounder with strong distribution channels to support organic growth. The business has grown FUM at 120% over 6 years but double-digit growth is a realistic expectation going forward.
• Strong alignment system between shareholders, management, employees and clients. Total inside ownership is approximately 75% with both Founders owning 73.5%.
• The stock is valued cheaply at 10x earnings, down from 16x late last year at IPO. The stock appears to be a “heads I win, tails I don't lose much” proposition.

Business Summary

GQG Partners (GQG) is a global boutique asset management firm focused on active equity portfolios. The firm is led by the Founders Ravij Jain and Tim Carver who started the business together in 2016. Since launching the business, GQG has grown its FUM from 800 million to 90 billion USD, presenting a 112.5-fold growth or 120% CAGR in approximately 6 years.

GQG has been able to grow organically by utilising diversified distribution channels across Institutional, Wholesale and Sub-advisory. A high-level overview of each distribution channel is described below.

• Institutional (represents 50.8% of FUM): institutional investors use equity research teams dedicated to evaluating and selecting asset managers for their respective institution. Clients in this channel include insurance funds, pension/superannuation funds, sovereign wealth funds and ultra-high net worth investors (generally defined as individuals with US$30 million or more in investable assets). The client segmentation for this channel is diverse with Top 5 clients accounting 12% of FUM and the Bottom 80% accounting for 75%.
• Wholesale (represents 14.4% of FUM): this channel is focused on centralised brokerage/advisory platforms, independent financial adviser networks and independent financial advisers.
• Sub-advisory (represents 34.9% of FUM): in these arrangements, the financial ‘sponsors’ create the investment vehicle, manages the marketing and distribution. The sub-advisor would then offer their expertise on parts or all of the fund. One of GQG’s most significant sub-advisory relationships is the one they have with Goldman Sachs. GQG has leveraged Goldman Sach’s sales and distributions channel to add more than 20 billion in FUM. The clients in this segment are typical retail and wholesale.

GQG have a dedicated sales professional team across Institutional and Wholesale comprising of about 31 team members. In its Sub-advisory segment, GQG is able to leverage the relationship of the sponsor to gain access to more than 1,000 sales professionals.

GQG’s financial drivers is typical of an asset manager; the net revenues make up management and performance fees whilst the operating costs simply comprises of all other running costs. This is shown in the table below.

 

Source: Company data.

Quality

GQG has been able to make a stand in the highly competitive industry of asset management for the combination of 3 reasons.

Firstly, GQG’s business model has undermined the traditional legacy model used by many asset managers which imposes high management fees and have a heavy reliance on performance fees as a revenue driver. In a world that is increasingly short-term, clients are demanding market-beating returns over a shorter period of time than ever before.

Under the traditional model, asset managers are faced with a trade-off dilemma between risk and reward. On the one hand, if these managers chase higher returns to meet the performance demands of clients to outperform the benchmark on monthly or quarterly basis, they are faced with a greater chance of blowing up the fund. If a more cautious approach is taken, as it should, an asset manager is at career risk by underperforming his or her competitors. This dilemma has only intensified over time with short-termism becoming so prevalent.

High fees come with high expectations, and the power of incentives suggests that more often than not, asset managers will do what it takes to beat the benchmark or recoup losses for the next reporting period. The traditionally high fee structure causes asset managers to naturally concern themselves more with career risk.

The effects of career risk are further exacerbated by the fact that investors are becoming increasingly sophisticated, asking questions like, ‘Why should I pay for an active manager who takes on more risk, can’t beat the market? Why don’t I just index?’. The Boston Consulting Group research on Global Asset Management below shows that over time, investors have been accelerating towards passive investing strategies. This structural change will mean that only high-quality active managers will have a chance of surviving over time.

 

Source: The Boston Consulting Group ‘Global Asset Management 2021: The $100 Trillion Machine’ (July 2021).

To counter position the challenges that are present in the traditional high fee models, GQG has a business model that fronts into these dilemmas. Firstly, GQG promotes low-cost management and performance fees. GQG is one of the lowest cost active managers in the industry; the average weighted management and performance fee at 0.49% and 0.4% respectively.

Source: Company data.

The revenue mode also has a minor reliance of performance fee as a driver for business growth. Only 1% of GQG’s revenues are performance fees. Although, the revenue profile experiences less volatility than a traditional asset manager, the fee structure actually helps align Rajiv and investment team think longer term, reduces career risk and to be in an easier position to promote capital preservation due to its low cost.

This part of the thesis opines that whilst GQG continue to upend the well-entrenched and formidable incumbents, the incumbents will seem paralysed and unable to respond in a timely matter. The incumbents will have to decide how they will deal with the new superior business model, whether to adopt it or not, and what the consequences are of each action. Any existing asset managers that do adopt GQG’s model will see revenue declines of up c.50% (or more), and certainly net income declines of more than 50% due to operating deleverage. Any asset managers which decide to launch new funds will then have to compete with the size and scale of GQG. Smaller asset managers will have difficulty competing for scale, whereas larger asset managers will have difficulty in being nimble enough to make the business model transition.

GQG’s counter position has attracted significant FUM and thus experience significant organic growth. GQG has sustainable net margins of about c.70-80% with current ROE of 104%. GQG’s business model has allowed it to become a capital-light compounder, paying out 90% earnings in dividends.

Secondly, Co-Founder and CIO Rajiv Jain has been able to market his experience and a differentiated philosophy that promote organic FUM growth. Rajiv has over 30 years of investment experience, an established track record, previously serving as the co-CEO, CIO and Head of Equities at Vontobel Asset Management. Rajiv helped build the business from less than $400 million in FUM to just under $50 billion in 2016 before starting GQG. GQG’s differentiated philosophy is focused building a bottom-up, concentrated portfolio of high-quality compounders, making capital preservation the key consideration for all strategies. The since inception performance for each of the 4 funds and the alpha vs beta analysis are shown below.

Source: Company data.

Source: Company data.

Although the barriers to entry into the global asset management industry is quite low, gaining market share is extremely difficult. Larger asset managers with long-standing reputations typically already have a mature existing client base. Clients typically have a strong hesitancy to change asset managers if it’s a brand or relationship that they have come to trust. The stronger the brand, the stronger the barriers to entry. GQG has been able to quickly build a name for itself in the industry using Rajiv’s name, associating relationships with high-quality names such as leading firms like Goldman Sachs and AustralianSuper. Clients and prospective clients qualify such relationships by social proof, growing the brand perception and ease of acceptance in a highly competitive industry.

Lastly, GQG’s boutique asset management model means that staff and clients are materially aligned. Rajiv Jain holds 68.8%, Tim Carver holds 5.6% and the rest of the total employees hold 1.5%, totalling the insider holdings to 75.9%. All of Rajiv Jain and Tim Carver's remunerations are received below the line, paid all in the form of dividends. No stock based compensations, no performance rights. In addition, 95% of the proceeds that Rajiv Jain and Tim Carver received upon IPO are also vested in the GQG strategies over a 7-year period.

Eligible employees will also have their discretionary bonuses paid by combination of cash and a deferred bonus award subject to a three-year vesting period, with the employee’s deferred bonus amount exposed to one of the various GQG’s investment strategies. 

This material alignment is important in considering a margin of safety. GQG listed at a price of $2 in October 2021 and has since materially declined 31% to $1.38 in a matter of 5 months. Put in context, the valuation of the firm upon IPO was roughly has 16x, since declining to about 10x. By association, GQG seems to be caught in the market storm caused by Magellan’s dilemma of poor performance, high fees, FUM outflow, the resignation of Brett Cairns, CEO, and exit of Founder Hamish Douglass.

 The margin of safety of this investment can therefore be viewed from the following perspectives.

• From the viewpoint of a founder, a public listing is a potential opportunity for them to sell down over time and take some risk of the table. At rich multiples, who wouldn’t do it? However, at currently depressed multiples, it appears unlikely that Tim and Rajiv would materialise a sale. It appears further unlikely considering the IPO price, the growth history of the business and the potential upside of future growth. If they did now, they would sell themselves short.
• If they do start to sell down, when they do, it would create a huge amount of float (due to significant ownership) and enough time for an investor to gauge a sense on the implied future growth trajectory and management’s perception on valuation.

These are inherently inbuilt dimensions of risk control for an investor that contribute to the quality of GQG as an investment proposition.

Growth

GQG is sitting on $90 billion USD in FUM, with a total market share capture of c.0.4% FUM representing the global equity market. This represents ample opportunity to grow and scale by leveraging GQG’s distribution system. To illustrate an image on the potential upside, the number 1 company possesses c.10% FUM in this market.

 

Source: Company data.

Going forward, GQG’s FUM growth will naturally taper downwards albeit still at a high rate. For the calendar year ending 2021, net revenues grew by 74.9%, FUM grew by 36.1% and net income grew 81.6%.

 

 Source: Company data.

GQG’s growth will be driven by its continued ability to promote its brand and further the reach of its global distribution team and digital capabilities. GQG centralises its focus on investing, outsourcing all operational back office needs to their global strategic partner, Northern Trust Company. This includes processing transactions, reporting, corporate actions, etc.

The levers for growth will be centred around launching new products and the fruits of the 3 new dividend focused strategies are yet to be realised. The dividend focused strategies will bring great appeal to the Australian market, with the superannuation assets valued at $3.5 trillion as The Association of Superannuation Funds of Australia. GQG has a total penetration of $5.1 billion in the Australian market across all channels, suggesting significant runway for just this pathway of growth.

So then, if the company is so profitable why did the company list? The key reasons GQG states in its prospectus that it decided to become a publicly listed company in order to:

• expand the types and value of financial incentives that we can provide to our existing employees and to attract future employees through the issuance of equity-related securities;
• permit the realisation over time of the value of equity held by the business owners (e.g., Rajiv Jain and Tim Carver) and;
• provide increased visibility in retail markets, especially in Australia. Given Tim Carver’s experience running the ASX listed Pacific Current Group, GQG has listed here in Australia.

With insiders having such a large stake within the business, there is a great incentive for insiders to grow the business long-term, and at a minimum, realise a greater multiple to give their equity a run for their money.

Valuation

To evaluate the worth of the business, let’s firstly evaluate the risks. The permanent loss of capital of this investment proposition can be split into 3 risks: valuation, business earnings, and balance sheet/financing risk. The valuation of the GQG vs comparable businesses on the ASX are listed below, with accompanying 3-year FUM CAGR, its operating margin and average base management fee margin.

 

Given the growth profile of GQG, the earnings multiple appears to be greatly discrepant relative to peers. The risk multiples contracting therefore appear to have a low probability.

The risks of the business earnings are related to FUM outflows typically due to long periods of underperformance. This risk can also be seen as key person risk with Rajiv being CIO. Rajiv’s long history of reputation for solid performance in the industry and his skin in the game offset the immediate effects of business earnings risk to a certain degree. To offset this risk further, Morningstar is a great resource to gain an insight advantage. Morningstar shows the live rolling performance which can be used to assess FUM, performance and hence, the expectations of others prior to the company's earnings release.

Other risks that may present itself is if a similarly reputable name enters the industry with the same strategy of attacking fee compression, high legacy performance fee models and therefore fuelling further competitive pressures.

The balance sheet/financial risk is not present with GQG being debt free.

From a valuation standpoint, the total expected return can be broken down into:

• Yield – At a current P/E of 10 and a payout ratio of 90%, the dividend yield is 9%.
• Growth – As with any fast-growing company, returns will have to taper off. Using historical figures will not be sustainable as they would soon own the whole market. A conservative yet realistic growth rate for the immediate term could be 15%. This would give GQG $181 billion in FUM over a 5-year period, which represents a double to today’s FUM. A conservative approach should be used to account for any unexpected market downturns which may affect FUM. Any additional growth from GQG adding more funds to its portfolio, pulling a debt lever for acquisitions, or its continued undermining of the fee compression in the active management industry, would be a bonus.
• Multiple Expansion – GQG is deserving of a higher multiple and appears to have been caught in the Magellan market storm. A re-rate could see the earnings multiple double, to be further in line with the likes of Perpetual or Pinnacle. This would add 15% in returns p.a. if accounted over a 5-year period.

The total return could therefore yield various outcomes. If this proves to be a tails situation, an investor could stand to return just the dividend yield of 9% p.a. with what appears to be little downside for a multiple contraction. If this proves to be a heads situation, an investor could stand to return a yield of 9%, growth of 15% and a multiple expansion return of 15%, generating a total return of 39% p.a., or a 5-bagger (excluding dividends), over a 5-year period.

Disclaimer: This blog post contains information that is general in nature and is intended for educational purposes only. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.