Fund managers and exchanges likely winners post-COVID-19

May 21, 2020 / Blog

Figures show that recurring revenue, high ROCE, economies of scale and active management put fund managers and exchanges at an advantage when it comes to recovery. Overall the wider financial services sector is in a strong position to recover despite initial losses.

Fund managers and exchanges are likely to emerge from the COVID-19 crisis as the best relative performers compared to other financial services sub-sectors, and while lenders will be at a disadvantage, figures show the sector overall appears in a strong position to recover in the post-virus environment. These are the key findings of the latest ‘finn-ancial Times’ quarterly sector note, published today.

Fund managers in strong position

The report favours fund managers, in particular, as they benefit from high recurring revenues, economies of scale and an increasing interest in active fund management, which may become an increasingly important trend among investors following the COVID-19 market crash in Q12020.

Figures show that the FTSE All-Share fell 26.6% in the first three months of the year. And while in financial services it was only wealth managers that outperformed the market (falling 24.9%), it was fund managers that experienced the most robust bounce backs in the recovery that followed, gaining 41%. 

The report screened a broad range of financial services companies with a ROCE of 20% or higher, and found that almost half were fund managers. While sharing similar characteristics with wealth managers, which are in a slightly less strong position, fund managers are more scalable than wealth managers due to the higher requirement for face-to-face meetings and the advice relationship of the latter, meaning a slight drag on scale benefits due to increased headcount costs.

Exchanges well positioned too

Exchanges (firms that are either a true exchange such as the London Stock Exchange, or otherwise offer a ‘go-between’ model) fell by 28.7% to levels not seen since 2017, before recovering 20%. Many exchange sector participants, however, benefit from increased activity and due to the diverse nature of the sub-sector although many may see a fall in immediate demand as a result of increased uncertainty, high margins and ROCE mean the companies are well-positioned to take advantage of a recovery in underlying target markets.

Also, exchanges are, in many ways characterised by innovation, since leaders need to differentiate a relatively common service, brokerage, by offering it in a more efficient way or scaling it up to gain market share quickly, which should help drive their business models in these difficult times.

Lenders probably most at risk

Lenders, on the other hand, are the relative losers in the financial services sector. They initially fell by 45.7%, recovering by only 17% subsequently. Demand for credit to buy goods and services has decreased, an issue worsened by the fact that many borrowers are unable to pay back existing credit as a result of the economic slowdown. The hope for lenders is that only a short initial period of pain has to be overcome, with both forbearance and the Government furlough scheme aiding a borrower’s ability to repay, until a rapid economic bounce back permits demand to return and interim repayment difficulties to ease.

Market is pricing in higher cash over opex

The report ordered sample financial services companies by the highest number of months of operating expenses covered by gross cash and drew a line under those with 12 months or more of expenses paid for by cash. The results showed that the market is applying a premium to the companies with stronger balance sheets. The seven companies with 12 months or more of expenses covered by cash (Alpha FX, Plus 500, London Stock Exchange, Schroders, IG Holdings, Tatton Asset Management and Hargreaves Lansdown) are down just 6.2% YTD as opposed to -24% for the All Share and -21% for companies with less than 12 months of cover. These companies largely have high ROCE, as well as exposure to market volatility and increased transactional income.

Outlook promising

Overall, the outlook is promising for the broad financial services sector. Although the crisis has introduced a severe demand-side shock, to some extent the financial sector is protected from this since even money is now largely non-cash, while technology is in most cases well embedded, meaning that face-to-face services can be offered electronically. When it comes to increased unemployment, assuming the initial shock is contained and subsequent recovery is sharp, financial services and sub-sector participants may be able to escape the more drastic effects seen in other sectors such as retail and manufacturing. Furthermore, Government assistance should act as a defence against both lower demand and rising unemployment.

Top picks post-COVID-19 include Impax Asset Management (IPX), Liontrust (LIO), Premier Miton (PMI), Mortgage Advice Bureau (MAB1), K3 Capital (K3C), Tatton Asset Management (TAM), Manolete Partners (MANO) and Nucleus (NUC)

Nik Lysiuk, Research Analyst (Financials) at finnCap, comments: “Although we do not yet know the full economic impact COVID-19 will have, this report indicates that fund managers and exchanges will be the relative winners within financial services with the sector also well-positioned to bounce back. This is good news for companies throughout the wider UK economy, whether they are established large corporates or ambitious growth enterprises, which will all rely on access to funding and investment to accelerate their own recovery as well as that of the wider economy.”

These are the key findings of the latest ‘finn-ancial Times’ quarterly sector note, published today.


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