Jupiter AM: A good business but is it a good investment?

In this 4,000-word investment review I look at Jupiter Fund Management PLC, a self-described high conviction active asset manager.

• Jupiter is a leading active fund manager focused on equity funds for UK retail investors sold through financial advisers
• Assets under management have grown fairly consistently for most of the last 35 years
• Profitability is high, even among fund managers where high returns on capital are fairly common
• Jupiter recently made a large acquisition to increase fund diversity and economies of scale
• At 212p Jupiter’s dividend yield is above 8%, largely due to the pandemic and declining assets over the last two years

Table of Contents

• Fund management by name, fund manager by nature
• Jupiter has a mixed and initially confusing financial track record
• Weak capital employed growth is due to management buyout side effects
• Fee revenue growth has been squeezed by the rise of passive funds and a shift towards lower margin asset classes
• Jupiter’s profitability is high relative to other successful fund management businesses
• Low debts and low capex leave Jupiter with a strong balance sheet and good cash flows
• Jupiter has a long history of focusing on its core business
• Active fund managers are cyclical, but the business model has a built-in tailwind
• Passive funds are a threat to Jupiter’s assets under management and fund management fees
• Being the best fund manager can help negate the fee squeeze from passive funds
• Being the biggest active fund manager is another route to offsetting the passive fee squeeze
• Coronavirus should be a short or medium-term problem for most fund managers
• Summary: Jupiter seems to be a good business but I’m not sure it’s a ‘special’ business
• Jupiter’s share price appears to be attractive with an exceptionally high dividend yield
• Jupiter: A good business at an attractive price, but is that enough?

Fund management by name, fund manager by nature

In its 2019 annual report, Jupiter Fund Management describes itself as a high conviction active asset manager with the following purpose:

Our purpose is to help our clients achieve their long-term investment objectives. We do this by delivering growth for clients through investment excellence, which generates superior returns after all fees. Individuals and institutions can access these active returns through our mutual funds, investment trusts and segregated mandates.

Jupiter Fund Management 2019 Annual Report

This is pretty standard stuff for a fund manager and the business model is as you’d expect:

Jupiter earns fund management fees as a percentage (typically less than 1%) of client assets under management (AUM). The more assets it manages, the more fee revenue (and hopefully earnings) it generates.

Jupiter’s primary focus can be broken down in various ways:

• Asset class: Equities (49% AUM)
• Investment vehicle: Mutual funds (88% AUM)
• Distribution: Financial/wealth advisers (60% AUM)
• End investor: UK retail investors (74% AUM)

The company is listed in the cyclical Financial Services sector, is a member of the FTSE 250 and has a market value of around £1.2 billion.

And as with every company I look at, Jupiter has paid a dividend in every one of the last ten years.

Jupiter also has a very high rank on my stock screen, ranking 9th out of 207 dividend-paying FTSE All-Share stocks based on a combination of quality and value criteria.

Jupiter has a mixed and initially confusing financial track record

The first thing I do when analysing a company is create a blank copy of my investment spreadsheet and then fill it with data from SharePad.

For Jupiter my spreadsheet shows the following headline results (green means okay, red is a red flag):

• Growth:
  • Growth Rate: 6%
  • Growth Consistency: 61%
  • Growth Sustainability: 100%
  • Growth Quality: 81%
• Profitability:
  • Average net return on sales: 25%
  • Average net return on capital: 15%
• Financial liabilities:
  • Debt to Earnings Ratio: 0.6
• Cash flow strain:
  • Capex to Earnings Ratio: 3%
• Valuation (share price 212p):
  • Dividend Yield: 8.1%
  • PE10 (price to 10yr avg earnings): 9.1
  • PD10 (price to 10yr avg dividend): 11.2

Most of the headline results are highlighted in green, which means Jupiter’s combination of quality (growth, profitability, debt, cash flows) and value (yield, PE10, PD10) is good overall, at least on paper.

The single red flag is Growth Consistency, which measures how often capital employed, revenues and dividends went up over the last ten years.

This chart shows why Jupiter’s Growth Consistency is relatively weak:

Overall, Jupiter’s earnings and dividends have increased steadily and rapidly over the last ten years, although both have fallen in the last couple of years (in the case of dividends this was caused by the removal of the special dividend rather than a dividend cut).

What really holds back Jupiter’s Growth Consistency is the lack of consistent growth in either capital employed or revenues.

This is a problem because meaningful long-term earnings and dividend growth is impossible without long-term revenue growth, and highly unlikely without long-term growth of capital employed.

So my first question is, why have capital employed and revenues not grown (and why did capital employed fall off a cliff between 2010 and 2013)?

Weak capital employed growth is due to management buyout side effects

Although Jupiter has existed since 1985, it spent much of that time as a subsidiary of Commerzbank. Jupiter then relisted on the London Stock Exchange in 2010 following a management buyout (MBO) in 2007.

The purchase price was £740 million and, as is often the case with MBO’s, a lot of debt was used to fund the buyout.

After the buyout Jupiter was saddled with £375 million of debt, but by the time of the flotation in 2010 that had reduced to £281m.

It was always management’s intention to reduce those debts to zero within a few years of listing, and that’s exactly what they did. And, since borrowings are a key part of capital employed (along with equity capital and leased capital) this also reduced capital employed.

So in this case, the reduction in capital employed between 2010 and 2013 was actually a good thing.

Capital employed also decreased further on a per share basis as the number of shares increased by more than 50% between 2010 and 2013. This was also related to the management buyout, as new shares were issued to key employees during the first few years post-MBO. This was basically an incentive for them to stay onboard after the company went public.

If we adjust Jupiter’s track record to remove those post-buyout debts and the post-buyout increase in shares, Jupiter’s track record starts to make more sense:

This is starting to look like the kind of steady growth I like to see, but revenues have still barely changed over the last ten years and that definitely needs to be investigated.

Fee revenue growth has been squeezed by the rise of passive funds and a shift towards lower margin asset classes

For asset managers, revenues are fund management fees which are charged as a percentage of assets under management. So it seems sensible to look at both revenue and AUM growth over the last ten years.

At first glance this looks like a nice chart of steady growth, but while AUM are up 78% over ten years, revenues are up just 30%. Now, 30% revenue growth over a decade isn’t bad, but it’s an annualised growth rate of just 3% so it isn’t fantastic either.

Why have revenues grown so much more slowly than assets under management?

The obvious (and tautological) answer is that Jupiter’s fund management fees have shrunk as a percentage of AUM.

For example, from 2010 to 2013 management fees averaged 1.4% of AUM, but from 2017 to 2019 those fees have averaged slightly less than 1% of AUM.

This is due to a mix of factors, primarily:

1. Jupiter’s increasing exposure to bond funds which typically charge lower fees than equity funds,
2. the increase in fee transparency following regulatory changes known as the Retail Distribution Review and
3. the continued rise of low cost passive funds

I think the rise of passive funds is the most serious headwind as it could have a long way to go and could also drive further regulatory pressure.

In the US for example, despite massive inflows to passive funds over the last two decades, passive funds still only account for about half of all US fund assets. In the UK only about a third of fund assets are in passive funds.

And with some passive funds offering zero or near-zero fees, active funds are likely to face continuing pressure to either reduce or justify their fees.

Of course, the market won’t go entirely passive and at some point there will be a natural balance between passive and active funds, but where that balance lies is anybody’s guess.

One way to offset passive fee pressure is to increase economies of scale, so many fund management groups have been doing mergers and acquisitions. Jupiter has also gone down that route, and I’ll have more to say on that later.

For now, I think it’s prudent to assume that Jupiter’s organic revenue growth may be capped at something like 3% or so for the foreseeable future.

In summary then:

Once the side effects of the management buyout are stripped away, Jupiter has a track record of reasonably steady growth, although revenues have been held back as fund fees have been squeezed by asset class diversification, regulation and the ongoing rise of low cost passive funds.

At this point I’d say Jupiter still looks like it could be a high quality business, so let’s take a look at what is perhaps the most important metric of them all: profitability.

Jupiter’s profitability is high relative to other successful fund management businesses

Jupiter has produced consistently high levels of profitability, with returns on sales averaging 27% over the last ten years and net returns on capital employed (including leases) of more than 18% once the side effects of the MBO are stripped out.

In fact, return on sales has averaged more than 30% in the last five years, which is exceptionally high.

Both of those profitability ratios easily exceed my rules of thumb:

Much of this profitability is due to the nature of Jupiter’s business, and other fund managers have profitability ratios which are also far above average.

That’s partly because fund managers don’t need lots of expensive capital assets such as factories or machinery to make profits. But it’s also because most investors aren’t really bothered if a fund charges 0.5% or 1.5%, even though there’s a threefold difference in revenue for the fund manager.

However, Jupiter’s profitability is high even among its peers, and that is a sign that this may be a high quality business run by capable managers.

So Jupiter is a highly profitable business which has grown fairly consistently for a long time. But has it fuelled that growth with borrowed money, and are there any drains on cash flow that we should be worried about?

Low debts and low capex leave Jupiter with a strong balance sheet and good cash flows

As I’ve already mentioned, Jupiter had a fair bit of debt after the MBO, but by 2014 those debts were entirely gone and that is still pretty much the situation today.

Capital expense (capex) is also tiny, as you might reasonably expect from a fund manager. Jupiter has no need for expensive capital assets such as factories and machinery, so there is no meaningful cash drain from the need to upgrade or expand those assets.

Overall then, Jupiter’s numbers look good. It’s grown, it’s highly profitable and it has little or no debt and no need for heavy capital investment.

Now let’s have a look at Jupiter’s business.

Jupiter has a long history of focusing on its core business

Personally I like to invest in companies that focus on building a leadership position in a relatively narrow core market before attempting to dominate closely related adjacent markets.

Jupiter definitely fits that description.

Jupiter is an active fund manager, it’s always been an active fund manager and although in recent years it has diversified its business by client type (institutional in addition to retail), asset class (fixed income in addition to equities) and client geography (European in addition to UK), management have recently reiterated their intention to strengthen and re-focus on the core business of managing mutual funds for UK retail investors.

Active fund managers are cyclical, but the business model has a built-in tailwind

Being focused on a narrow core business is good, but it doesn’t mean a thing if the core market is sliding towards oblivion (high street retail may be a good example of that).

Fortunately, equity fund management has a built in tailwind which means the market for truly active fund managers is likely to continue growing over the long-term, despite shorter-term pressures from passive funds.

That tailwind comes from a combination of population growth, economic growth per person and inflation.

Population growth means more investors, and economic growth per person means each investor has more money to invest. That means more clients and more assets per client for fund managers over the long-term.

In addition, inflation, population growth and economic growth are very likely to drive up profits and therefore equity prices over the long-term. This will further increase assets under management and fund management fees.

However, even though total assets under management are very likely to keep going up over the long-term, active funds may struggle to maintain their share of the market.

Passive funds are a threat to Jupiter’s assets under management and fund management fees

In the US, passive fund assets have grown from 3% of the fund universe in 1995 to 14% in 2005 and more than 40% today.

This trend towards passive funds is expected to continue, with mainstream core or “closet index” active funds seeing the biggest related outflows.

However, passive funds often do a poor job of providing exposure to niche or specialist strategies such as value, small cap, emerging markets and so on. That’s why truly active fund managers (those who focus on outperformance through differentiated strategies) are still expected to grow, despite the increasing popularity of passive funds.

Having said that, the passive phenomenon is definitely impacting most active fund managers, with fees being squeezed almost regardless of a fund’s specialist strategy.

Overall then, I have mixed feelings about active fund managers:

• Long-term growth: The active fund management market is very likely to grow over time as investment markets will never be 100% passive.
• Medium-term pressure: Fee margins could be squeezed to the point where revenue and earnings growth are slow for many years.

I think there are two main ways that Jupiter can try to offset fee margin pressure: 1) Be the best and 2) be the biggest.

Being the best fund manager can help negate the fee squeeze from passive funds

Obviously if you are a fund manager and you’ve beaten the market by 10% per year for 50 years, then investors will still happily pay fees north of 1%.

However, such fund managers are either a) rarer than a planet hosting a technological civilisation, b) difficult to attract without paying astronomical salaries or c) likely to head for greener pastures at some point by setting up their own fund management firm.

So far Jupiter has proven itself relatively capable of attracting and holding onto high performing fund managers.

That’s partly because it pays them lots of money, but it’s also because it gives fund managers a lot of freedom in terms of how they invest. There is, in fund management lingo, no House View at Jupiter.

This has worked well so far, and Jupiter has grown its funds under management from 13 billion euros in 2000 to 21 billion euros in 2007 to 32 billion pounds in 2013 to 50 billion pounds in 2017 (AUM switched from euros to pounds after the management buyout).

Some of that growth is due to the increase in the underlying value of companies and stock markets, but much of it is down to Jupiter’s ability to attract and retain top talent who can outperform and attract cash inflows from clients.

However, this strategy of focusing on elite fund managers does involve key person risk, and successful fund managers have a habit of exiting stage left to set up their own firm.

The highest profile example of this was Neil Woodford’s departure from Investec, where at the time Woodford controlled more than £30 billion of client assets.

Jupiter is not immune to this risk. In 2019, Jupiter suffered outflows of £4.3 billion (about 10% of AUM at the time) as a direct result of fund manager Alexander Darwall’s decision to set up Devon Equity Management.

Being the biggest active fund manager is another route to offsetting the passive fee squeeze

With great size comes great economies of scale, and that applies to fund management as much as any other business.

However, Jupiter is still a relative minnow with assets under management of less than £40 billion at its recent interim results. That may sound like a lot, but my model portfolio holds several financial services companies with significant asset management businesses and each has at least ten-times that amount under management.

That lack of scale is not ideal, so increasing scale is one of the reasons why Jupiter recently announced its intention to acquire Merian Global Investors.

Merian has AUM of £17 billion, which are being brought onto Jupiter’s systems. That boosts Jupiter’s AUM by almost 50%, increasing economies of scale scale as well as diversifying AUM across a wider range of funds, asset classes, styles and geographies.

Although I can see the sense in this acquisition, it is fairly substantial at a cost of almost £400 million. That’s more than three-times Jupiter’s average earnings and triggers one of my red flags:

In this case Merian’s business is closely related to Jupiter’s core business of fund management. It’s also being paid for with new shares rather than debt, so I’m not overly worried about the integration or financial risks of this deal.

Of course, no investment analysis would be complete today without mentioning the pandemic, so here are a few thoughts:

Coronavirus should be a short or medium-term problem for most fund managers

Jupiter and other fund managers are reasonably well-placed to ride out the pandemic without too much damage. That’s because:

• it’s relatively easy for Jupiter’s employees to work from home
• Jupiter’s clients don’t have to leave home to generate fees (their assets just have to stay invested in Jupiter’s funds) and
• equity markets are unlikely to go to zero

Given the way some markets have rebounded, you could be forgiven for thinking the pandemic’s economic and market impacts are already almost over.

Personally I think the economic fallout has barely begun, and that could keep equity market valuations low for a few years while also putting people off from investing in the first place (or selling funds if they’re already invested).

So the next few years could be tough, but I don’t see the pandemic as an existential threat to Jupiter. In fact, I think it’s highly unlikely that Jupiter will need to raise additional debt or equity funding to see it through the crisis.

Summary: Jupiter seems to be a good business but I’m not sure it’s a ‘special’ business

Here’s a quick review of what I like about Jupiter:

• Market growth: The active fund management industry is likely to keep growing for a long time yet, as more investors will have more money to invest in growing equity markets using niche specialist active strategies
• Focused business: Jupiter has a long history of focusing on its core fund management business and equity funds for UK retail investors in particular
• Highly profitable growth: The company is highly profitable and has been able to double assets under management every ten years or so for at least the last two decades
• Low debts: Jupiter has a long track record of using little or no debt and doesn’t need to buy or lease lots of expensive machinery, factories or offices
• Leading provider: It’s one of the best-known active fund managers in the UK with a good track record of outperformance

And here are the main things I don’t like:

• Not the market leader: I prefer to invest in businesses which are dominant market leaders in their core business. Jupiter is a well-known brand but I certainly wouldn’t call it the leading active UK equity mutual fund provider.
• No obvious durable competitive advantage: Jupiter has a long track record of success, but it isn’t entirely obvious how it has achieved that success. My guess is that Jupiter’s edge is its ability to attract and retain high quality fund managers. But that seems like a very easy to replicate approach. Admittedly Jupiter seems to have used this approach for a long time, but I can’t help thinking it isn’t a durable economic moat.
• Pressure on margins: The continuing shift to passive funds is a concern for pure active fund managers like Jupiter more than it is for investment firms that do other things like infrastructure investing, wealth management, complex solutions for institutions and so on. Also, ever increasing regulatory costs make scale ever more important, and Jupiter is still quite small relative to many other fund managers.
• Lack of financial data: The company was a subsidiary of Commerzbank before 2007, so that doesn’t leave investors with a lot of detailed financial data to analyse.

Overall then, I quite like Jupiter, its focus on active fund management and its track record of AUM growth, high profitability and low debts.

However, there are some obvious headwinds and I’m struggling to see what (if anything) makes the company ‘special’.

On that basis I would say this:

• I might invest in Jupiter if there were no other attractive opportunities, but it doesn’t stand out as a company I’d really like to own. At least not yet.
• If I used a five-star system for scoring companies, I would give Jupiter four stars.

Jupiter’s share price appears to be attractive with an exceptionally high dividend yield

As I write, Jupiter’s shares are priced at 212p. That’s 66% less than their peak price of 630p in early 2018.

Back then, Jupiter was on a roll with AUM up to more than £50 billion, a near-100% gain over five years.

But since then things have not gone so well, and in the company’s recent interim results its AUM had fallen to £39 billion, about 20% below their peak.

That reduction in assets was largely due to declining equity and fixed income markets in 2018 and a departing star fund manager in 2019.

And now of course we have a pandemic, which pushed Jupiter’s AUM down to £35 billion in March and Merian’s down from £22 billion to £16 billion.

So as you might expect in the middle of a global pandemic, Jupiter is currently having a bit of a rough time and that explains much of its 66% share price fall.

After such large share price declines, Jupiter’s dividend yield is now north of 8%.

Management are so far sticking with their progressive dividend policy, but such a high yield suggests that investors think Jupiter is likely to cut its dividend significantly.

If we step back from a myopic focus on the current dividend and instead look at the price relative to the dividend over multiple years, then Jupiter seems to be even more attractively valued.

For example, although the dividend yield is 8% or so based on the 2019 dividend of 17.1p, Jupiter had in fact consistently topped up the base dividend with special dividends over the last few years. So the average dividend from 2014 to 2018 was actually 28p.

If Jupiter ever manages to get its dividend back to 28p, that would be a dividend yield of 13% at its current price of 212p.

That’s certainly food for thought, especially as Jupiter has a track record of growth.

• I think Jupiter is attractively valued at 212p.
• I’d give it four stars for value at anything under 250p.

Jupiter: A good business at an attractive price, but is that enough?

So I think Jupiter is a four-star business trading at a four-star price. That’s pretty good, but I still don’t think I’ll be investing just yet.

That’s because I have three basic rules of investing:

1. Diversity: Own a diverse group of companies
2. Quality: Buy and hold quality companies which seem to have durable competitive advantages
3. Value: Buy and hold those quality companies at attractive valuations

Jupiter almost ticks the quality box. The only thing it’s missing is an obvious durable competitive advantage, but that’s an important thing to be missing.

On the value front, I do think Jupiter is attractively valued at its current price. But for now that isn’t enough, and the reason is diversity.

My model portfolio (and my personal portfolio) already holds:

• two companies where fund management is a major part of their business
• five companies where fund management is a minor part of their business

Although these companies are fairly different from one another, operating in different countries with different client types and different specialisms, they are exposed to similar regulatory risks to varying degrees.

The last thing I want to do is add more exposure to the same regulatory risks, so until I sell one of those holdings I doubt Jupiter will make it into my portfolio.

And if I didn’t already own those companies?

There’s a good chance I’d invest in Jupiter at anything under 250p, but it would depend on what other opportunities were out there.