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Is Pinnacle now in the buy zone?
You might not have heard of Pinnacle Investment Management Group (ASX: PNI), but you’ve likely heard of or invested in one of its 16 affiliate managers. Founded by investment management doyan Ian Macoun -who is currently Managing Director and owns 9.6% of the company – Pinnacle provides the seed capital, administration, and distribution for upstart fund managers in exchange for an equity stake.
The value proposition is attractive for fundies. Most have left bigger institutions to run their own shop, but don’t want the troublesome task of looking after non-core activities like client services and compliance. By partnering with Pinnacle, the fund manager gives up some of its revenue (management fees) while retaining the lion’s share of any bonus (performance fees) if the strategy succeeds.
Pinnacle effectively breaks even on the support function, with the majority of profits derived from management and lesser extent performance fees from affiliates. Both parties are aligned, and should a manager fail to perform, Pinnacle often has invested negligible upfront capital. With a stable of 16 affiliates, it’s well-diversified and built an impressive stable of managers across equities, fixed income, credit, and private markets. Illustrating Pinnacle’s success to date, 85% of affiliates with a track record of at least five years have exceeded their respective benchmark.
Pinnacle identifies three pillars of growth for the future:
1. Grow the existing business and affiliates via inflows and distribution
2. Build new affiliates from scratch or expand via new initiatives
3. Acquisition of affiliates
It has a track record of executing on each. FUM has grown at a rapid pace of 26% per annum over the past ten years. The business has launched successful managers Hyperion, Firetrail, Solaris, Plato, and Antipodes from scratch while acquiring profitable interests in Coolabah and ResCap. Pinnacle has a decent runway of growth ahead with a fund capacity of $300 billion with current funds under management (FUM) of $93 billion.
With a history of growth in addition to soaring asset prices at the beginning of the pandemic, it’s little surprise the Pinnacle share price surpassed $18 per share or a price-to-earnings multiple of 55 in November. However rising investor concerns over inflation, interest rates, and invasion has tamed FUM growth, leading to a 54% share price correction.
Valuing a fund manager is more of an art than a science. To be conservative, it’s best to use management fees as the floor for earnings. Management fees are paid independent of performance. Performance fees, by definition, rely on beating the benchmark which is seldom guaranteed year-to-year. Given its growth profile, buying Pinnacle shares at a management fee multiple of 20, or around $7 per share would be decent buying. This would imply a 5% cash yield with a track record of growth and performance fees as a cherry on top.
However, the business will need to hit double-digit growth to justify a valuation above its peers. If FUM growth stagnates or outflows begin, the Pinnacle share price will plummet. Share price risk is real, and investors need to be ready to sell quickly should the business not live up to its past success. Other risks to Pinnacle include concentration, competition, and performance. Over 78% of its portfolio is exposed to public equities, a highly competitive market with many alternatives. Passive strategies continue to take market share, while institutions are looking for a point of difference – usually in private, credit, and alternatives – when handing over funds to active managers.
Management has previously noted this trend and has made moves such as buying a 25% stake in private equity shop Five V Capital to bolster the portfolio. Performance has always been a risk, but one to keep close track of as it can change quickly. Just ask Magellan Financial Group (ASX: MFG), whose share price is down 65% since July and trades on just 6x management fees after falling behind its benchmark leading to global equity FUM halving in just six months.
Overall, Pinnacle is a business solving a genuine pain point for fund managers. It has a track record of execution and is approaching an attractive valuation point. But with many market-linked ASX shares, investors need to tread with caution that the business and its affiliates continue to outperform and grow FUM.
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