Tatton Asset Management (TAM): Growth potential overpriced?

1. Introduction

Sorry this initial post is ridiculously long, but hopefully it gives everyone a bit of detail. Tatton Asset Management provides services to UK independent financial advisors (IFAs) including fund management, consulting services and mortgage broking. A few commentators, notably Jeremy Grimes on Sharepad, have covered the group’s attractions.

The group’s financials are pretty straight-forward and I am particularly interested in the prospects and risks associated with the business’s franchise or business model. For an industry outsider, with the difficulty in getting the relevant information, this is sometimes more difficult than financial analysis, but nevertheless important and often covered in less detail elsewhere including other bulletin boards.

The group was founded in 2007 by Paul Hogarth, an experienced financial services entrepreneur who successfully founded and sold previous IFA related services businesses. The group floated in July 2017 at 156p per share, with selling shareholders receiving £40m of proceeds (with c. £20m apparently to the founder and spouse) and £10m retained within the group. Since then, it has performed well and the current share price is c. 290p.

Initially, the group provided consulting and mortgages to IFAs. In 2009, it formed a joint venture with Octopus to provide funds. In 2012, the Octopus fund manager Lothar Mentel came across to Tatton, which acquired Octopus’s stake shortly afterwards in 2013 and launched Tatton’s discretionary fund management business. Now, group effectively comprises two divisions: fund management and IFA services.

For mainly regulatory reasons, increasingly IFAs focus on financial planning (including risk appraisal and asset allocation) and are moving away from selecting and managing individual assets. The fund management division was formed to address this regulatory-driven outsourcing need and the nub of Tatton’s investment case is its potential to at least double AUM to c. £15bn over c. 3 to 4 years largely organically. At that point, it would be worth considerably more and could be an attractive target for a large fund management group. This is also effectively a bet that a significant proportion of sufficiently affluent end clients will seek human advice, at some additional cost, over DIY or automated advisory services.

2. Fund management (Tatton)

This division accounts for 81% of FY(Mar)20 operating profit before central costs.

Business

Tatton provides “on platform only managed portfolio service as discretionary fund manager working exclusively for IFAs”. Breaking this down:

a) “Platforms” : refer to c. 14 platforms that “house” the end client’s general dealing account, ISA, SIPP or other pension scheme. This allows the client and IFA to see and manage all the investments in one place. The platforms include Aegon, Alliance Trust, Amber, Aviva, Hubwise, 7IM, Standard Life and Transact. Tatton is apparently platform agnostic.

b) “Managed portfolios” : are portfolios that match clients’ risk and investment appetite as agreed with the financial adviser. There are a range of 29 funds that with various levels of risk and investment approach. The asset alloacation and risk is regularly reviewed and rebalanced (which is the bit small IFAs struggle with).

c) “ Discretionary fund management ” means Tatton makes the investment decisions etc. and is effectively a unit trust or mutual fund manager.

d) “ Exclusively for IFAs ” means Tatton’s funds are only available to IFA clients via their IFA and are not available on a retail basis. Tatton almost uniquely and very deliberately does not compete with the IFA for the customer relationship.

Tatton is set up solely to serve IFAs. It operates across all the major platforms, has invested in IT with IFAs specifically in mind, provides communications that IFAs can share directly with the clients and at c. 15 basis points (bps) provides the lowest cost products in the market (which allows IFAs to demonstrate best value to their clients). Tatton reviews and rebalances to ensure the funds meet their regulatory criteria. By outsourcing, the IFA should also save on compliance and administrative costs. The competitive landscape for the same or potentially substitute services is discussed below. Tatton also offers “white label” funds for its larger customers.

According to the regulator (FCA), about two thirds of IFA revenues relate to ongoing rather than “one off” advice. This creates recurring revenues for the IFA and a flow of new capital into outsourced providers such as Tatton.

For many years, financial regulation of the retail market has aimed to increase transparency, match risk and reduce cost. Major legislative drivers have included Markets in Financial Instruments Directives 2004 and 2014 (MIFID 1 and 2) and the UK’s Retail Distribution review. These have had a wide-spread impact across all parts of financial services. In relation to IFAs, the aim was to move away from opaque commissions to more transparent fees. In terms of fund management, IFAs produce a financial plan with their clients with clearly agreed risk parameters. The investments are increasingly required to match these risk categories (1 to 10 with 3 to 8 by far the most frequent). This requires review and rebalancing, which in turn favours larger discretionary fund managers. The failure of star managers (e.g. Woodford), illiquid funds (e.g. property and small companies) and recent market volatility have made it increasingly difficult for in-house operations to manage within the regulatory requirements.

Market

The obvious question is: is the market big enough or growing quickly enough to give Tatton a reasonable chance of reaching the scale envisaged by the investment thesis?

The UK IFA landscape splits as follows:

UK IFA firms appear to be unevenly distributed with a few large firms, but with a long tail of small firms. St James is the “gorilla” of the market with c. 4,300 advisers. Founded in 1991 and listed in 1997, St James pioneered the large IFA model of the “group” managing marketing, compliance and asset management, leaving each adviser focussed on advising/selling – and many make a very good living doing so. Other large groups include Quilter Cheviot (1,800 advisers) and Tilney (300). There are also a few private equity backed “consolidators”. The rationale for the larger groups is create consumer brands to drive customer acquisition, spread increasing compliance costs across a network and to create asset management scale. These larger IFAs are unlikely Tatton customers.

If we assume the first two and two thirds of the third category are relevant, Tatton has an “addressable” market of c. 5,000 firms with c. 12,500 IFAs. Tatton currently works for 595 firms or 12% of its addressable market. The revenue per adviser is consistent across firm sizes, so if we assume AUM follows the same pattern very crudely about 50% of UK IFA funds under management could be relevant to Tatton.

Tatton are open about market consolidation risk. Effectively Tatton is a bet on a reasonable number of IFAs staying relatively small and local. A network of service providers appears to provide many of the benefits of operating a larger company (e.g. compliance, fund management etc…), while retaining independence and customer ownership.

Another way of considering the addressable market is to look at the share of AUM is allocated to discretionary model portfolios. AUM in Tatton’s segment has apparently grown from £5bn in 2011 to £62.5bn in 2019. Tatton appears to have a 10% share of the segment. The key variables are overall Platform AUM growth, the DFM share and Tatton’s share of DFM. The trends for each appear favourable.

Competitive Position

The key question here is: even if the market is big enough, does Tatton have sufficient competitive advantages to achieve a market share envisaged by the investment thesis?

Tatton has scale and cost advantages over its current competitors. In the segment, with £7bn AUM it is nearly twice as large as its nearest competitor and Tatton prices at 15bps versus its cheapest competitor at 30bps. Many competitors are other IFA groups or stockbrokers, which compete with the IFAs. Based on some pretty cursory research, it appears that FE (part of a financial data group backed by Hg private equity since 2018) and LGT (the UK arm (with 358 staff) of LGT a large multi-national fund management group with Lichtenstein roots) are Tatton’s main competitors. Even then, Tatton’s pure IFA focus, relationships, lower cost and AUM scale would appear to give it an advantage. As the Tatton certainly appears to have cost and performance advantages, with its IFA focus and Paradigm, the service may also better.

The obvious potential competitors are the very large global fund managers and so-called “robo advisers”. Vanguard, BlackRock and Fidelity have not entered the market directly, but their products are likely to be used in the model portfolios. I have a hunch that the current market for discretionary risk rated portfolios may be too small to interest them, the UK specific regulatory burden may be unattractive and they prefer a direct customer relationship. There are several “robo” advisers that collect customer information online, allocate the assets based on a risk assessment and then invest. At the moment, they do not seem much cheaper than Tatton. Tatton is effectively a bet that some, especially those over 50, who have most of the investable wealth and more complex advice needs, will seek an advised route. I suspect it will be some time before the “robo” advisors make a material inroads and initially they will be more successful with more tech savvy younger clients with less complex needs. It is also worth noting that Blackrock is Tatton’s largest institutional shareholder with 15.8%.

Financials

A summary divisional P&L is set out below:

There is an obvious growth in AUM that with operating leverage drives higher profits and margins. In 2019, as part of an internal reorganisation to reduce the group to two divisions (fund management and services), the platform business in Paradigm was transferred to Tatton. This effectively shifted £2.7m of profit to fund management – you could take a cynical view of this.

AUM Growth

As set above, Tatton’s funds have performed well and over a sensible period would expect AUM to grow at c. 4-5% pa.

It seems that there is about a 15% asset loss each year (or 85% retention). The IFA customer base results in a steady stream of new capital from end clients. In 2019 it was net c. £90m per month and in 2020, even with Covid, it was c. £94m. According to Tatton, there are significant opportunities within its current client base.

Overall, Tatton would appear to have a strong chance of increasing its AUM substantially over the next five years. Equity Development’s forecast, which is presumably managements lower case, is £13bn by 2024.

3. IFA Services (Paradigm)

This division accounts for 19% of FY(Mar)20 operating profit before central costs. As it is not central to the investment thesis, this section is brief.

The formally separate consulting and mortgage businesses have been combined into one division ostensibly for strategic clarity, but both divisions were looking sub-scale in comparison to fund management.

This business provides compliance, business and technical advice to IFAs largely on a monthly fee model. The regulatory drivers are strong. Paradigm provides face-to-face audit style services focussed on process, training, documents and systems. It also has a central technical helpdesk that takes c. 500 calls per month from c. 100 firms. It also provides an IFA backoffice software solution (“AdviserCloud”) and has software partners for financial planning software.

The group offers mortgage services to DA IFAs. For many clients, their house is their most valuable asset and they seek advice from their IFA. Pardigm offers a “whole of market” (i.e. not limited or tied) approach to its clients and uses it buying power to get mortgage or insurance (life, critical illness or property) that would not be available to individual IFAs. Paradigm receives a share of the IFA’s fee. Again, there are strong regulatory drivers.

While consulting may appear subscale, its contribution to the group’s relationships with IFAs may go beyond financial.

4. Management, Shareholders and Operations

The key executives are Paul Hogarth and Lothar Mentel.

Paul founded Bankhall in the late 1980s, an IFA services business, which he sold to Lynx Group that was in turn sold to Scandia and Paul joined the main Board in 2002. He left in 2007 to set up PPL. Paul has also been active in the private equity sector as the majority shareholder in Citation group, a HR and legal compliance group sold to ECI in 2012. Paul was also a shareholder in Perspective Financial, an IFA consolidator, sold to CBPE earlier this year. Paul appears to know the space well, is a savvy operator and has made himself, and his fellow shareholders, material capital sums.

Lothar is a fund manager who appears to have worked at a range of “blue chip” organisations. Early in his career, he designed Barcalys Multi Manager funds. In 2012 he left a position as CIO at Octopus to join Tatton. His experience suggests he could scale as the AUM grows and the fund portfolio becomes more complex.

The website suggests that there is a sensible executive team in place that would not need to grow much to accommodate much greater scale. The organisation has been designed for its current purpose rather than reconfiguring a legacy organisation.

The group operates from a single office in Wilmslow. A quick Google search suggests property is c. £18psf in the area, which is much cheaper than operating out of major cities. (Paul Hogarth owns the office building in his pension fund – common with owner managers, but a bit odd in decent sized plc.) The NW has financial services history with lots of credit card and payments businesses based in the area, where there are good quality staff available for materially less than major cities. The group appears to be IT savvy and has scaleable systems for both businesses.

The major shareholders are as follows:

tatton4

5. Group Financials

The business unit P&Ls are covered above and the group financials are pretty straight forward. A brief summary of the group financials is as follows.

P&L

In the interest of brevity, I have not set out the balance sheet or cash flow, there is not a great deal to comment on. Similarly, I have not presented key ratios that are readily available on Sharepad and elsehere, but the group has strong margins (e.g. EBIT 40%) and good cash conversion on a small capital base, which produces attractive returns on capital (e.g. ROCE 51%). If the group adds AUM on a relatively fixed cost base these should improve further.

Valuation

I have attempted a rather crude sum-of-the-parts valuation, which involves allocating central costs and attaching a multiple to each division:

To the extent possible, central costs are allocated to one of the divisions. The assumption is that the divisions would be purchased privately and £400k is stripped out for operating as a listed company. After that, the remaining central costs are allocated equally. It could be argued that fund management is larger financially, but on the other hand, services has the much greater headcount.

The valuations are driven by services. The much larger SimplyBiz is valued at 14-15x and there is a size discount for services, but there would be a number of well-funded purchases with significant synergies that would support that value.

The c. 17x for fund management appears high but is materially lower than most peers. Given its attractive niche and strong “flow” Tatton might command a premium valuation. The valuation of 1.7% of AUM appears low for a sticky investor base albeit with low fees.

The current group prospective PE is 21.5x and EBIT/EV is 14.6x. While there may be some disruption to the services division, AUM is already ahead of pre Covid levels and the monthly flow back to a net of great than £90m of new capital.

The management base case appears to be £13bn AUM by FY(Mar)24 that produces £14.5m EBIT and c. £20m cash (which I assume is after generous dividends). If the £14.5 is adjusted to £15m at a 18x multiple (higher proportion of recurring fund management) the market cap would be £270m. Assuming a debt free/cash free sale, the valuation would be c. £290m, which on a per share basis would be about £5.20 versus the current £2.90. In reality, the management team probably have more ambitious plan.

6. Conclusion

In looking at Tatton, my perception of the services division has declined. On the other hand, the the fund management business appears to have unique attractions. The operation was designed with the sole purpose of serving IFA clients as effectively and cheaply as possible. Regulation continues to drive clients and IFAs to model portfolios on platforms. Tatton now has the powerful advantage of being the leading brand, with the lowest cost and decent performance. IFAs have ongoing relationships with their clients, which should continue to drive a flow of funds to Tatton.

This model produces good cash conversion with little capital requred with a high return on capital. These attractions are currently highly valued, but often it is better to buy a quality business at a fair price.

The management team are very incentivised and have a track record of exiting businesses at opportune points in the cycle. Paul Hogarth is 60 and is unlikely to want his current £25m locked up in Tatton for ever.

It is always interesting to reflect on what could go wrong and my “worry” list would be as follows.

a) Reputational damage

This would be something that would cause the IFAs to move their clients’ money elsewhere. These would include a regulatory error (e.g. not matching portfolio to risk), a cyber hack or an IT failure that prevented access to client money.

b) Consolidation

The model relies on a reasonable number of smaller IFAs that suit Tatton’s model rather than bigger groups with in-house discretionary fund management. I still believe that enough well off clients will favour advice from smaller local advisers.

c) Larger competitor

Tatton wins due to scale within a niche and focus. At the moment, there do not appear to be any major challengers, but FE and True Potential appear to have the most potential.

d) Investment performance

If Tatton performed very poorly for a prolonged period, it may suffer outflows. It appears that Tatton specialises in asset allocation rather than “chasing alpha”, which would appear to make significant underperformance less likely.

e) Key Man

Paul Hogarth has been at the centre of Tatton since its foundation and if he was removed the group may suffer. Paul appears to have been involved in other businesses during his time at Tatton. I suspect while important he is more of a figurehead and door opener than a “day to day” manager.

f) Valuation

The valuation is high and Tatton is no bargin. Adverse news would inevitably lower the toppy multiples and reduce the enterprise value materially.

While Tatton is not cheap and there are some blemishes, it is rare to see a potential high growth, cash generative, high return on capital business with a clearly incentivised management team that have grown this business and consistently made money for their investors elsewhere. As a result, I have dipped my toe into these waters with a small stake.

I would welcome views.

Hi Mike

Many thanks for the wonderful post! Some thoughts from me:

Yes, no problem with the accounts. Niggles include the revenue/profit restatement for 2019, and the regularity of exceptional items, but the general picture is one of high margins, decent cash flow and of overall ‘quality’.

I am an industry outsider, too, so I can’t give much of an insightful perspective. I guess the thinking ought to start at the client-IFA and IFA-Tatton relationships. How often do clients change IFAs, and how often do IFAs change DFM services? Not sure myself. But I suspect change is not too frequent, which ought to be positive for Tatton.

Like all fund management businesses, Tatton is ultimately dependent on its investment results. Poor relative performance at its funds will eventually filter through to the IFAs and clients, who may then choose to leave and invest elsewhere.

What is interesting is Tatton’s 0.15 bps charge is lower than Transact’s standard 28 bps fee for simply running the IT platform (Transact is owned by quoted firm IntegraFin). Seems to be more money running the IT platform than doing the hard work of actually selecting the underlying investments for the poor client!

I do think a market for IFAs will continue to exist despite robo-advisers and index trackers etc. People will still want the reassurance from a human who (should) know what he/she is talking about. I recall writing for Motley Fool 20 years ago about the advantages of DIY investing and bog-standard trackers over managed funds, and yet IFAs have not yet died out and Tatton has clearly thrived in the sector.

The impressive figures here are indeed the sizeable net inflows, which are about £1bn per year for the last four years that has helped take AuM from £2.7bn to £6.7bn. Something is clearly going right, either with the sales force or the investment returns or both.

FWIW, I am invested with City of London Investment, a fund manager where new client money has been frustratingly small compared to total AuM — which is why its P/E has often bobbed around 10x.

The 17x multiple is perhaps the crux of the valuation case. I would want more details of the peer ratings of 17x or more.

FWIW, SBIZ bought Defaqto, which arguably is a more predictable business than fund management and was valued at c16x post-tax earnings for c40% operating margins, double-digit revenue growth and significant annual-subscription revenue.

I feel 17x EBIT for Tatton as a private business is a tad rich. I recall Nick Train values his investment business at sub-10x earnings for the Lindsell Investment Trust, but can’t find a link to prove it. I did find this link that says his investment business can be valued at 1.5% AUM, which for Tatton = £105m with AUM at, say, £7bn.

AUM of £13bn at 2024 could be achievable I guess, given the steady £1bn/year of client inflows since 2017 and AUM at c£7bn now.

The excellent points you mention about management, addressable market, regulatory influences and even office costs all appear in order and so we are left with the basic questions for all fund-management companies:

  • can new client money continue to roll in?
  • what level of growth is the share price already pricing in?

Maynard

Maynard,

Thanks for your helpful comments.

On performance, it appears to have been fine, but I suspect they are not chasing alpa. The following is an extract from the results presentation.

image

As always, I would be cautious with self-proclaimed performance particularly when the benchmark appears pretty subjective. However, at worst, it is probably not bad.

The respective charges are odd. My only thought is that the platforms have to deal with retail investors which requires physical (e.g. manned phones) and regulatory (e.g. reports on performance and costs) infrastructure. Despite both platforms and fund management appearing to be competitive markets, many operators seem to make high operating margins.

I suspect new money is a bigger driver of AUM growth than performance. As I recall, c. 55% of the AUM is in equities, so I doubt there will be a material “alpha” effect.

On valuation, I will have a look at Defacto. Equity Develpment provide “research” that is paid for by the company, which is quite clearly marked as marketing material rather than indepedent research. Nevertheless, it is a useful starting point. Their latest note covers the comparable point (but for obvious should always be taken with a pinch of salt).

The note is quite deliberately publically available, but if adding it to a post is a “faux pas”: my apologies.

As you say, there are some unanswered questions and a (too?) full valuation, but for all the reasons set out in my earlier post, I will keep watching and digging.

Hi Mike,

I have started to look a bit deeper into fund managers (will publish a write-up on Liontrust here soon).

The impressive point about Tatton is the sizeable net inflows of new client money, which are about £1bn per year for the last four years and has helped take AuM from £2.7bn to £6.7bn. For 2020, £1.1bn new money on £6.1b year-start AUM is a fantastic 18%. I make the previous three years at 22% (2019), 26% (2018) and 36% (2017).

Sure, the rate is declining but that’s to be expected as the firm grows. I would say if the business can sustain say a 10% rate of new client money, then the share price will retain its premium. ED reckons the overall AUM growth rate will reduce to 12% pa by 2025.

That ED note also puts Tatton’s rate of new AUM into perspective (right chart)

For now I think the main issue boils down to valuation. If you are basing your sums on a private-company basis, then I would note Liontrust’s recent purchases of private managers. Liontrust paid a consistent 1.3%-1.4% of AUM for three different fund managers, which sort of tallies with how Nick Train values his management business.

Tatton ought to be valued at more than 1.5% AUM because of its listed status and the benefits that gives to investors (share liquidity, better reporting etc).

ED looks at PEs in the sector (left chart above), though I would be cautious of that comparison. AJ Bell is a different type of business while the 39x PE for Liontrust is based on reported earnings before various adjustments. If you take the adjusted EPS figure, Liontrust trades at c21x. I would therefore check the validity of the PEs for Brooks MacD, Impax and Rathbones just to make sure P/Es of 28-plus are indeed the case.

Maynard
PS No problem linking to any public document.

Maynard,

Thanks. Key is flow of new money, which is pretty consistent at c. £1bn pa albeit that each year that is a smaller percentage of a larger base. Even if Tatton continues to grow AUM, the current valuation is punchy (i.e. at best, it is no bargin).

Model is a bit different, not necessarily better or worse, than other fund managers. The key drivers are regulatory rather than pure performance. Liontrust’s new money is driven by relative performance. For Tatton, regulatory and cost drivers appear more important. Also, Tatton’s AUM appears to be c. 55% equities while others seem to be long only equity managers with presumably higher volatility.

I will comment on Liontrust in the relevant thread, but interestingly they are Tatton’s third biggest shareholder.

Gresham House is also on my research list.