Spending more to capture a bigger market share can shake market confidence. AJ Bell has given investors reason to watch the cost line more carefully.
Revenue and earnings came in ahead of market expectations over the 12 months to the end of September. Higher interest rates were behind the beat, pushing up the margin the investment platform provider made on the cash clients hold in their accounts. Better still, guidance for the revenue margin on direct-to-consumer (DTC) assets this financial year has been raised to around 45 basis points, much higher than the 36 basis points that had previously been guided towards. That will be accompanied by a better margin on advised funds, of 21 basis points, up from 19 basis points previously expected.
• No alarms at AJ Bell despite investors spending less
A jump in costs takes the shine off the boost to revenue from higher rates. Distribution, technology and staff costs were 17 per cent higher last year, ahead of a historical norm of a high single-digit rate of growth. The bulk of the increase came from wage inflation and costs associated with the launch of two new products: Dodl, aimed at those new to investing, and Touch, designed for financial advisers managing lower-value client portfolios. There has also been a “step-change” in pushing the brand, something the investment platform has “done at the right sort of scale in years gone by”. Michael Summersgill, the new chief executive, said.
More interesting is guidance for the current financial year, when costs will rise by another 21 per cent, above the 15 per cent growth expected by analysts. Some of that represents inflation, but even without that cost pressure expenditure guidance would be around the mid-single digits. Analysts at Shore Capital reckon the increase in cost guidance limits the upgrade to earnings forecasts for this year to the mid-to-high single digits.
The boost to revenue that the investment platform provider expects to derive from higher rates, together with the operational gearing benefits that are intrinsic to platform providers like AJ Bell, means the pre-tax margin this year is still expected to be two percentage points higher than last year’s 35.6 per cent.
The question is what happens to the profit margin during the next financial year, which runs to September 2024. The “vast majority” of the benefit from any future rate rises will be passed on to customers, which means there will be no material boost to revenue margins for AJ Bell. Without that cushion, there is the risk that if spending on promoting the brand, hiring and technology remains elevated, then it could eat into profits. Summersgill and co have pointed towards “controlled” expenditure and investment next year, but then management said the same of spending this year when it issued guidance in May.
Margins will naturally be at the mercy of to what extent AJ Bell can retain assets on its platform. Assets under administration closed 2 per cent down at the end of September, at £64.1 billion, but that was a result of market oscillations rather than investors pulling cash. Net inflows were £5.8 billion, down on the prior year when locked-down consumers were flush with cash, but still above pre-pandemic levels. But that doesn’t mean investors aren’t feeling the pinch. The annual cash contribution by existing customers to the DTC platform reduced from to £10,000, from £13,000, last year.
Investors also have to question how much of that expected future growth in clients and assets is already baked into the share price. Smaller scale and superior organic growth expectations mean AJ Bell trades at a premium to the behemoth, Hargreaves Lansdown. The shares have derated as markets and investor confidence have weakened, but still trade at almost 26 times forward earnings, compared with a multiple of 15 for Hargreaves.
Volatile markets put more emphasis on the trajectory of spending by AJ Bell. The severe markdown suffered by Hargreaves offers a lesson in surprise splurging.
ADVICE Hold
WHY Higher spending could limit profit growth in the near term
Fidelity China Special Situations
Fidelity China Special Situations is hardly giving prospective investors the hard sell. Sentiment towards Chinese stocks is “dire” and “probably the worst”, Dale Nicholls, the trust’s manager, has seen.
Chinese stocks have been caught in a perfect storm. The zero-Covid policies that have resulted in strict lockdowns and choked economic growth; a regulatory crackdown has weakened the appeal of the technology companies that dominate Chinese indices; and a downturn gripping the property market.
The result? The net asset value declined by 10 per cent over the six months to the end of September, worse than the 5.5 per cent fall recorded by the MSCI China Index, the trust’s benchmark. Like its peers, Fidelity has endured a heavy fall in its share price since the start of last year, one that left its shares at an 11 per cent discount to net asset value. That is broadly in line with the level just prior to the pandemic.
The trust invests in stocks listed in China and in Chinese companies trading on exchanges elsewhere. What marks out Fidelity from its three UK-listed peers is its focus on small and mid-cap companies. The idea is that because such companies are less well covered by market analysts and are on the radar of fewer investors, there is more potential for those stocks to be mispriced by the market.
While the trust is underweight giants such as Tencent Holdings and Alibaba compared with the benchmark, those companies are its largest holdings at a combined 17.4 per cent of assets. Nicholls thinks the tech reforms have peaked, with regulation around data protection and sharing and anti-monopoly measures already laid out. Clarity could help engineer a re-rating in those tech and media stocks.
Stock selection is centred around a refocusing of the Chinese economy towards domestic consumption, with exposure to consumer names like the retailer Miniso, increasing earlier this year. Inflation and weaker discretionary spending could cause that sector to suffer, however. Given macroeconomic and regulatory risks pervading firms operating in China, the discount embedded in the share price is not that appealing.
ADVICE Hold
WHY Given the risks, the discount to NAV is off-putting
