2023-12-07 05:07:41 ET
Summary
- Invesco's growth has been disappointing, and its margins are eroding. The industry has experienced significant disruption, and Invesco is on the losing end.
- Its balance sheet remains strong, and funds continue to outperform, however. We do not believe this is enough to drive long-term value.
- IVZ faces challenges due to reduced demand for active funds, fee erosion, bear market conditions, and increased competition from passive strategies.
- The company slightly underperforms its global asset manager peers, primarily due to profitability.
- Invesco's stock appears overvalued when considering its declining performance and valuation relative to its peers despite trading at a discount to its historical average.
Investment thesis
Our current investment thesis is:
- Invesco is experiencing a deterioration in its commercial position due to reduced demand for active funds, fee erosion leading to reduced margins, the current bear market discouraging inflows, and increased competition from passive strategies such as ETFs and Robo Investors.
- Invesco slightly underperforms a cohort of global asset managers, primarily due to profitability, although its growth is good.
- Invesco is trading at a discount to its historical average but when considered in conjunction with its decline in performance and the valuation of its peers, the stock looks overvalued.
Company description
Invesco Ltd. ( IVZ ) is an investment manager that serves a wide range of clients, including retail and institutional investors, corporations, pension funds, and financial institutions.
The firm offers various investment services, managing equity and fixed income portfolios tailored to individual clients. In addition, Invesco launches mutual funds, exchange-traded funds (ETFs), and private funds across different asset classes such as equities, fixed income, commodities, and multi-asset strategies. The firm invests globally in public equity and fixed income markets, as well as alternative markets like commodities and currencies.
Share price
Invesco's share price has performed poorly in the last decade, significantly underperforming the market, having only returned just over 20%. This is a reflection of changing industry dynamics, increased competition, and a period of weakness in the business.
Financial analysis
Presented above is Invesco's financial performance for the last decade.
Revenue & Commercial Factors
Invesco's revenue has grown at a CAGR of 2% across the last 10 years, slightly below the rate of inflation during this period. This is a clear underperformance when factoring in the bull market experienced post-GFC, driven by relaxed monetary policy and economic development in emerging markets.
Business model
Invesco is a global asset manager, generating its earnings primarily through the levying of fees for the management of its client's funds. These fees are usually tiered, with the first being purely for the management of funds, based on assets under management ((AUM))/invested capital. There is then further scope for additional fees based on overachievement based on a target (performance/incentive fees).
As the following illustrates, Invesco is highly diversified by client domicile, nature of the client, and asset class.
For the reasons stated above, Invesco is incentivized to continually raise AUM through winning additional mandates to increase its fee-earning potential. In order to do this, it must show a relative superiority in the ability to allocate capital. Potential clients usually make allocation decisions based on historical performance (even though historical performance is not indicative of future performance.
Track record
The single biggest commercial factor for supporting growth is the ability to convey superior competency to markets. If (potential) clients believe they are better off with Invesco's peers, the company will be unable to raise new funds and its current clients will redeem their holdings to reallocate.
Regulatory requirements have made the process of comparison fairly transparent, with asset managers forced to disclose their performance relative to a benchmark. Presented below is a comparison of Invesco's actively managed funds to its peers. As the following illustrates, the vast majority of its funds are in the top half of its peer group beating the benchmark.
The level of outperformance noticeably improves the longer the time period considered, implying deep expertise in asset allocation. As the period increases, the risk of mean reversion increases, and so the fact this % is increasing implies quality management.
Asset management industry
The industry has experienced a significant shift from active to passive investing strategies. This has been driven by continued criticism of whether active management is "worth" it. All it takes is a quick Google of "Active investing underperformance" to see a host of articles discussing how active managers continue to fall short of passive investing. Active management, by nature, incurs increased fees to the client but comes with the commitment to greater focus on allocation and scope for outperformance.
As the following graph illustrates, the largest drawdown in AUM has come from active investment, with investors clearly unhappy with returns. This has been a consistent trend for a number of quarters. This is a stark contrast to Passive, which is actually experiencing inflows despite the weaker market conditions.
The concern here is that Invesco will see reduced AUM in its active funds relative to passive over time, contributing to the average fee per client contracting. As the below graph illustrates, Invesco is highly exposed to active funds, implying the impact on the business will be large.
Our expectation is for this to occur, as active funds are just not performing to the level required. Even star fund managers who outperform in a specific time period inevitably run into underperformance, many of which experience a noticeable reversion to the mean. We expect a large consolidation in the active fund space, with AUM localizing around fewer funds that can justify their fees.
This is further compounded by the rise of Robo-advisors. This poses a threat to Invesco due to their lower fees, and the emphasis on diversification and risk management, backed by technology-driven decision-making. For many consumers, this implies increased competency relative to a "human" and has contributed to rapid growth in the segment. Many of the large banks have acquired robo managers as a response (For example, JPM with Nutmeg ).
In conjunction with other passive investment strategies (Such as ETFs), increased competition, and the factors stated above, the industry is experiencing a downward pressure on fees. This is a serious headwind for Invesco, with the business unable to materially pivot despite a strong track record for overperformance. We believe this is a primary reason for the poor revenue growth during the historical period.
Current economic conditions represent a key risk to the near-term performance of Invesco. With high inflation and elevated rates, we have seen the onset of a bear market and financing uncertainty for millions of people. As a result of this, there has been a downward pressure on AUM, market performance, and the desirability to invest. For this reason, we are seeing soft AUM inflows, netted against above-average outflows. Our expectation is for this to continue until rates begin to decline and expansionary monetary policy can be initiated, which currently looks to be in 2024/25. Invesco looks heavily exposed given its large portion of retail clients, who are currently significantly impacted. Institutional investors take a long-term view and are unlikely to be erratic with funds.
Opportunities
Emerging markets present attractive growth opportunities for asset managers. With rapidly growing economies, the development of the middle class, and increased sophistication of asset classes, these regions are representing attractive markets. Invesco currently has strong exposure to Asia Pac and has been developing its presence in the region.
Further, Environmental, Social, and Governance [ESG] considerations have gained prominence in the investment landscape. This is driven by consumer pressures for businesses to improve their operations as a means of creating more sustainable and fair operations. For this reason, we have seen pressure for funds to invest in ESG assets and demand from consumers to have access to ESG funds. Invesco has launched ESG ETFs and is further expanding its sustainable offering.
Margins
Invesco currently has an EBITDA-M of 22% and a NIM of 14%. On an absolute basis, these margins are quite attractive. However, in consideration of this historical period, Invesco is underperforming.
The company has experienced a noticeable deterioration of margins in recent years, in part due to the shift toward a passive strategy, as well as a fall in the performance of many asset classes.
Our view is that margin improvement is possible as market conditions should improve, contributing to greater fees earned for a small marginal cost. This said, Invesco may face difficulties reaching the levels achieved prior given the factors discussed above.
Balance sheet
Invesco is conservatively financed, with a ND/EBITDA ratio of 0.2x. Further, the company's debt maturity profile is extremely attractive, reducing the risk of any large refis immediately coming due. This said, interest payments are a large portion of revenue and so we would like to see debt paid down or refinanced at more attractive levels.
Invesco generates strong cash flows from trading, with little in the way of capex required. As a result of this, the business is in a position to finance consistent buybacks and dividends.
Despite the buybacks, we have seen share dilution in recent years, although the absolute dividend yield looks fairly attractive.
Peer analysis
To assess Invesco's relative performance, we have compared it to the following businesses (Global asset managers).
Invesco is fairly comparable with the peer group chosen, although with a lower level of profitability while growing at a similar level. This is a reflection of the maturity of the industry, with a general harmonization among the leading businesses. Differences between the peers will likely be a reflection of slight differences in business models, as well as areas of specialization.
With slightly lower profitability but marginally higher forecast growth, we would expect Invesco to be valued at a small discount to its peer group, ~5-10%, as with mature businesses, margins are the most important indicator.
Valuation
Invesco is currently trading at a small discount to its historical average. We believe a discount is justified given the risk of further fee erosion, reduced demand for active funds, margin decline, the current bear market, and increased competition from passive funds.
We would suggest a ~20% discount to the EBITDA trading multiple, which would imply downside at the current share price.
Further, we assessed the company relative to the peer group discussed prior. Having applied a conservative 5% discount, we derive a (7)%-(10)% downside based on the current share price.
Key risks with our thesis
The risks to our current thesis are:
- An improvement in market conditions has shown an ability to supercharge margins (such as in FY21). If markets do begin a rapid improvement, we could see a strong year for the business irrespective of fundamentals.
- Expansion of passive funds and into emerging markets has the scope to offset the impact of softening demand for Active management. There is a strong execution risk here.
Final thoughts
Invesco is a highly regarded asset manager with an impressive track record of outperformance. The company's balance sheet is strong, its absolute margins are attractive, and distributions have been consistent.
We are, however, concerned by its commercial profile, which leaves businesses susceptible to the changing industry dynamics the company is currently facing. We believe Invesco is overly exposed which will contribute to an underperformance in the coming years.
At its current share price, the stock looks slightly expensive.
For further details see:
Invesco: Industry Headwinds And Threats To Its Business Model