Ashmore Group: Finance Director to leave the firm

Yesterday, 26 November 2013, Ashmore announced that Graeme Dell, the Group Finance Director, has decided to resign to pursue other opportunities. Graeme will remain at the firm until April 2014 and will handover to Tom Shippey who is currently the Head of Corporate Development at Ashmore.

Graeme joined Ashmore in 2007 and brought a wealth of financial and operational experience from previous roles at Evolution Group, Deutsche Bank and Goldman Sachs. Tom Shippey joined Ashmore in 2007 from UBS having advised on the Ashmore IPO in 2006. Tom holds the ACA qualification which was obtained in 1999 at PWC.

While Tom may be seen as more junior to Graeme with less experience, Tom has been in charge of the firm's corporate strategy in recent years and has the relevant qualifications and company knowledge to step up. However, Graeme's departure is a potential cause for concern given that Jerome Booth, the former head of research and co-founder of Ashmore, departed the company approximately 6 months ago. It would therefore be interesting to see where Graeme ends up and to better understand his reasons for leaving to identify any board level issues.

Ashmore shares opened 1% down after a 2.4% rally on the previous day. However, the shares recovered during the day, posting a 0.59% rise. The market does not appear to be too worried but it will be interesting to hear of any news that arises once shareholders have met with management.

Ashmore Group: Developing through Emerging Markets

Ashmore Group (Ashmore, "the group") is an asset management company focussed purely on investing in emerging markets with a particular focus on fixed income markets. Ashmore was created in 1998 following the management buyout of the Emerging Market (EM) asset management subsidiary of Australia and New Zealand Banking Group (ANZ). In 2006, the firm was listed on the LSE raising $2 billion. Revenue is generated by annual management and performance fees based on average assets under management which typically vary depending on the perceived risk/return of a specific investment universe and the targeted investor type. As at 31 March 2014, the firm managed $70.1 billion.
Unless noted otherwise, all sources will be from Ashmore and as of 30 June 2013 at the end of FY2012/2013. Please see the Disclaimer below.

Management

Mark Coombs, CEO, started Ashmore as a division of ANZ in 1998 before leading an MBO in 1999. Coombs, 52 and a Cambridge law graduate, led Ashmore through the EM wave of the early 2000s and the subsequent 2008 crash before the acquisition of Emerging Market Management (EMM) in 2011. Coombs holds approximately 41% of the outstanding shares in the company and therefore adds significant key man risk to the company.

Graeme Dell, CFO, was appointed in 2007 having held a similar role at the securities firm Evolution Group, since 2001. Dell has significant operational experience in emerging markets having established and developed Evolution's Chinese business and spent time working for Deutsche Bank and Goldman Sachs in Asia Pacific. A chartered accountant and graduate of Hertford College, Oxford, Dell brings significant operational, financial and management experience to the board. Graeme was replaced by Tom Shippey in November 2013. Tom led the firm's IPO in 2006 as a banker for UBS and was most recently responsible for Ashmore's corporate strategy.

In addition to the above, the board boasts five non-executive directors and a non-executive Chairman. Michael Benson, non-executive Chairman, joined the board in July 2006 and has over 50 years of experience in the city. Benson has held several senior positions in the asset management industry including Chairman positions at subsidiaries of Invesco from 1997-2005.

Strategy

The group's current strategy has three phrases which it hopes will lead to the development of a globally diversified institutional investor base and an attractive investment track record. Its first phase was to enhance understanding of EM debt in developed markets and grow the Ashmore brand as a premier EM asset management firm. The second phase looks to reinforce the Ashmore brand by introducing new investment funds and broadening the developed world investor base while the final phase seeks to attract investment from large institutions in emerging markets to further reinforce and diversify their investor base.

Phase 1 - Develop the sector, Develop the brand

Ashmore believe that the first phase is "largely complete", having developed a core, institutional investor base covering 89% of assets under management (AUM), growing assets from $24.9 billion in 2009 to $78.5 billion as at the end of September 2013.

From my experience of manager research, a solid institutional investor base is a particularly attractive characteristic for asset allocators since such clients typically focus on longer time horizons and will not pull assets from the firm during times of market weakness. In this situation, apart from the lost revenue from lower assets, frequent redemptions can mount and force the firm to raise cash in a poor market environment. Such activity can lead to investment losses, particularly with low liquidity instruments, and a negative multiplier effect of lower assets and lower revenue. Ashmore's high proportion of sticky assets is an attractive business characteristic capable of generating an annuity like revenue stream depending on prevailing market conditions. Indeed, Morgan Stanley reports that the group's average asset duration is approximately 5 years vs. 3-4 years for the group's European peers which aligns their clients with the group's long-term, bottom-up investment philosophy.

From the perspective of an equity analyst, the split of AUM between client types is less straightforward. While institutional mandates are held for longer with lower volatility, more retail-focussed funds attract higher net management fee margins. Personally, I like the institutional client base for two reasons: 1) despite lower margins, AUM is more resilient and dependable for long-term modelling and 2) it is an attractive attribute for asset allocators which can invest large amounts to drive revenue growth. However, Ashmore's net management fee margins (68 bps) are not negatively affected by its institutional base, due to its higher risk/return EM focus, and are higher than many of its competitors despite having a significantly higher institutional investor base. For example, Aberdeen's 1H 2013 net management fee margin was 49 bps but their institutional AUM was just 47% (as at 31 March 2013) and Henderson's 1H 2013 net management fee margin of 55 bps and institutional AUM of just 54% (as at FY 2012 / 31 December 2012).

After a relatively quiet year in 2011/12 which saw just $1.3 billion in net flows, possibly caused by investor caution towards EM on the back of the heightened volatility in the summer of 2011, 2012/13 saw strong net inflows of $13.4 billion with gross inflows of $27.2 billion on the back of stellar relative investment performance. As at 30 September 2013, AUM was $78.5 billion which is split as follows: 

% of AUM Av. management fee margin (bps) Blended Debt 25 55 Local Currency 22 60 External Debt 18 65 Overlay/Liquidity 12 17 Corporate Debt 8 93 Equities 7 73 Multi-Strategy 4 118 Alternatives 4 240

The group's local currency strategies saw the bulk of inflows with $8 billion while Equities suffered outflows of $1.3 billion. Local currency strategies provide a relatively low net management fee margin of 60 bps and it would therefore be encouraging to see AUM shifts towards higher margin products.

Ashmore is succeeding in its desire to build an attractive investment track record with 92% (86% FY 2011/2012, 71% FY 2010/2011) of invested AUM outperforming their respective benchmarks over three years. The majority stake acquisition of EMM in 2011, the dedicated EM equities asset manager, has been well-integrated into the business and equity performance is turning around with 87% (22% FY 2011/2012) of AUM outperforming over 1 year and 39% (21% FY 2011/2012) over three years which includes pre-acquisition assets.

Phases 2 and 3 - Developing the fund range and investor geography

Concerning product growth, the key milestone was the acquisition of a 62.9% stake acquisition of EMM in 2011 which brought $9.9 billion in EM equity exposure to the group. The number of public funds has steadily increased from 135 at the end of FY 2011 to 177 currently, as investors searched for yield from new sources. In FY 2012/13, Ashmore notably opened three Indonesian-focussed funds and broadened its exposure to equity, local currency and corporate funds. Thirty new segregated mandates were won over FY 2012/13 adding to the 11 in 2012 and 8 in 2011.

There is potential for significant growth as EM capital pools grow to accomplish the group's third strategy phase. To assist with this phase, Ashmore has developed a network of offices in 11 countries including 7 in EM including the establishment of businesses in Indonesia and China in FY2012/13. Headcount has grown from 142 in 2009 to 291 at the end of June 2013 including more than doubling support staff to scale up the business and drive AUM growth. Headcount in their regional offices is particularly important for the firm with personnel increasing by 50% since 2009 to focus on mobilising EM capital. While their AUM by investor geography has been relatively static over the past four years in many regions, there has been notable growth in Asia Pacific clients coupled with a decline in European markets.

	12/13	11/12	10/11	09/10
Europe ex UK	20%	21%	23%	27%
Asia Pacific	30%	29%	30%	21%
Americas	19%	20%	20%	20%
Middle East and Africa	19%	18%	14%	20%
UK	12%	12%	13%	12%

Positives/Catalysts

• Client base - Predominantly institutional bringing more dependable assets relative to its peers
• Margins - Industry leading EBITDA and average net management fee margins
• Rising rates - Despite the potential for short term volatility and low returns in EM debt, higher rates over the longer term may attract inflows and stronger performance leading to higher management and performance fees
• Structural tailwinds - There is evidence that developed markets institutional investors are seeking larger allocations to EM debt. 

Negatives/Risks

• Key Man Risk - Mark Coombes, CEO, is a 40% shareholder in the firm and seen as integral to the development and future success of the business
• EM Asset Class - The performance of the asset class, particularly local currencies and equities, are heavily dependent on funding sources from developed markets. With the expectation of QE tapering and future interest rate rises in the West, changes to the timing of such actions will greatly affect the group in the short-medium term
• FX - The vast majority of revenue is received in USD in line with the base currencies of most of the group's funds and segregated mandates

Financials/Valuation 

The group's market cap is approximately £2.5 billion and it has net cash of ~£500 million with the stock trading around 350p. EPS grew 12% to 30p in 2012/13 after negative growth in 2011/12. The firm has not made a loss for at least 6 years and has grown earnings in all years except 2008/9 and 2011/12 - most likely due to the underlying EM market conditions during those periods. Asset management firms' growth is largely dependent on macroeconomic events and Ashmore is possibly more susceptible than others given the high correlations between anything considered as EM. A Bloomberg/BofAML/BIS study from July 2013 expects the EM equity and debt universe to grow from $28.5 trillion to $79 trillion by 2020 and Ashmore will be well positioned to benefit from this.

The group is one of the cheapest in its sector, trading at almost 14x forward earnings vs. 17.5x for the GICS Global Asset Management & Custody Banks sector, 22x FCF relative to 30x and 35% ROE vs. 20% in the sector. The group has maintained a payout ratio of 50%+ in all years since it initiated a dividend in FY2007 with the dividend growing every year except for FY2009. The stock now offers a compelling dividend yield of approximately 4.0% which is above the subsector average of 3.4%. This compares favourably to Henderson (3.3%), Aberdeen (3.0%), F&C (3.0%), Invesco (2.6%) and Schroders (1.8%) while losing out to Investec (4.2%), Alliance Bernstein (7.0%) and Man Group (12.5%).

The group's adjusted 70% EBITDA margin and 35% ROE are both industry leading. The group has maintained an EBITDA margin above 70% for the past 5 years but it must be noted that management expect EBITDA margins to fall into the 60s over the coming years due to further growth in their institutional business and a reduction in performance fees in the wake of rising rates. 

Their industry leading EBITDA margin can be explained by two factors: 1) the EM debt focus which generates high management fees relative to other asset classes and 2) strong operational leverage following the easing of investment in distribution and a tight cost structure. To illustrate 1), Ashmore's management fee for its Emerging Market Corporate Debt fund (Inst. USD share class) is 115 bps. The Standard Life European Corporate Debt fund (Inst. EUR) commands a 50 bps management fee while the fees on the Nordea's US Corporate Bond fund (Inst. USD) are just 35 bps. Secondly, Ashmore's compensation structure is underpinned by a salary cap of just £100,000 at all levels of seniority and a cap on the group's variable compensation (VC) to EBVCIT ratio, which currently stands at 20%, after a 45% increase in employee bonuses in FY 2012/13 reflecting strong performance over FY 2012/2013.

While it is important to appropriately remunerate employees, Ashmore's funds are managed by a consensus team approach to prevent the potential for key fund managers leaving the group. In my own dealings with Ashmore, they have always been reluctant to reveal key decision makers and go to great lengths to emphasise the team approach. I believe that this is a good sign as the departure of key fund managers can weigh on fund performance and cause significant outflows. Indeed, the UK asset management industry has been hit by the departure of two "star" fund managers over recent months; Richard Buxton from Schroders, which caused £1.1 billion in outflows and Neil Woodford from Invesco Perpetual (IP). Neil Woodford, a 25 year veteran of IP and a UK equities expert, managed approximately £33 billion for the firm when he announced his departure on October 15th 2013. The market reacted immediately at the US-listed IP fell over 6% on the day as investors mulled their options. As reported by the Daily Telegraph on 31 October, clients have so far pulled over £1 billion from his funds, with redemptions from segregated mandates unknown. Many consultants cut their buy ratings on Woodford's funds and I would expect further redemptions once asset allocators and consultants have had chance to reach their conclusions.

Conclusion

Following the above analysis, I believe that Ashmore is attractively positioned to grow its AUM, and therefore revenues, given the structural tailwinds for EM investment. Its management is implementing a clear strategy to become a globally recognised EM-specific asset manager and to benefit from increased allocations to EM asset classes in the future. Moreover, it has a disciplined cost structure which promotes a meritocratic working environment while still providing ample incentives for those to succeed. In the event that senior members depart, the strong team approach should limit outflows as seen with star managers.

If you are looking to invest in an asset manager for at least 3 years, Ashmore is an interesting proposition given the company situation, an attractive dividend yield and the current valuation - I would rate this as a buy over three years assuming you can take the volatility. However, given that the stock trades at 350p after a strong EM run in recent months, there may be better entry points if the macro picture takes over.

Disclaimer:
This is not an offer or solicitation of an offer to buy/sell the securities mentioned. As of 13th June 2014, I hold an active position in Ashmore Group and I would encourage any readers to do their own research before making their investment conclusions. I wrote this article myself to learn more about company analysis. I have used publicly available sources and my own experience in manager research.