Sunday, 22 December 2013

CLIG - City of London Investment Group

There’s been a few mentions of CLIG on TMF before so I have to give credit to other write ups worth reading: Burgdorf’s, TMFFlaneur’s and TMFMayn’s but I’ll try and synthesise these all together, with my own comments.

CLIG are an asset manager focused on emerging markets (EMs). EMs have had a pretty rough time recently compared to developed markets and so are fairly out of favour (See the performance of the Vanguard EM ETF here) after having an exceptional run for many years prior to 2008. This has impacted CLIG pretty badly as revenues and earnings are tied to the assets under management (AUM) the firm has. This means that AUM falls in years where the EM indices fall, and rises when the EM indices do – consequently earnings also follow the same pattern.

From 2005 to 2011 CLIG grew AUM from about $1.6bn to $5.8bn through a combination of raising more capital and EM index growth and hence earnings also shot up from 11.85p to 34p. However, since then earnings have fallen to 24.6p as AUM has fallen to $3.7bn. This is due to the underperformance of EM markets as well as a big loss of one client who took their business in-house and away from CLIG. Due to this fall it’s likely earnings will also fall for next year – brokers forecast a consensus of 19.3p but TMFMayn has used the earnings model CLIG provide in their annual report to calculate that their current run rate is 17p.

CLIG have a great management culture and a pro-shareholder attitude. The founder, Barry Olliff, owns 11.4% of the shares whilst other directors, staff & ESOP own another 12.1% of the company. The staff also participate in a profit-share agreement, whereby 30% of PTP is allocated as bonuses, so staff have a strong incentive to grow earnings and shareholder value over the long term. It’s worth quoting Barry Olliff himself on this structure in 2012:
"As shareholders are aware, we run a business with a very simple business model. We collect fees from our clients for our services, we pay our bills which are both forecastable and to a great extent fixed. We don't use leverage, nor off-balance sheet instruments, nor do we trade derivatives as principal (other than occasional low level hedging). There are no associated companies or minority interests within the Group. We do not use tax havens. We do not handle client monies. We have a significant amount of cash in the bank relative to our size and we basically stick to what we know.
With regard to remuneration we continue to distribute 30% of our profits as profit-share. Our staff, clients and shareholders understand this formulaic approach. It's a pity that this approach has not been embraced by the financial service industry generally. As it is, in many parts of the financial services industry it seems as if losses are not the responsibility of mangers rather it's the shareholders who take the rap. Whilst our formulaic approach seems out of keeping with many in our industry, at least our shareholders have an idea that our returns go up and down together with theirs 
We have continued to manage our business very conservatively. We have continued to attempt to keep costs down. We do not spend shareholders' funds entertaining and we generally attempt to manage our business as if shareholders were present in our offices every day of the week. One reason I would suggest that expenses are kept down is because staff are either shareholders themselves or own shares via the CLIG ESOP. At present staff own (including ESOP ownership) 27.9% of CLIG shares, and 75 out of 82 of us are incentivised in this way (a handful of more recent recruits do not yet hold options).”
Importantly for an asset management firm, I think CLIG’s investment strategy adds excess returns (‘Alpha’ in the financial lingo) and hence is a desirable one for long term asset allocators (i.e. potential customers). CLIG’s main strategy is investing in closed-end funds, funds which have a fixed AUM (pre-distributions & returns) and have shares which trade publically. CLIG like to buy these when the share price trades at a discount to NAV, hoping to benefit when the discounts return back to their historical norms. They meet with all the managements of the funds they invest in and try to influence their use of strategies which help narrow that discount (87% of the funds they invest in have an Open Market Repurchase Program in place)) as well as investing in funds where they think the managers are better than average.

Unfortunately, this strategy has done badly recently as the Size Weighted Average Discount (SWAD) has risen from 8% back in 2008 to almost 14% in 2013, providing a headwind to their main source of excess returns. However, this headwind is sure to turn in to a tailwind as discounts mean-revert. This should also be a marketing advantage, as this is a simple message to sell to new clients (“Come invest now at the highest discounts we’ve seen in years and take advantage of the tailwind for excess returns!”). In fact, CLIG are looking to do just that and given the recent loss of a client have capacity now to add new clients and expand AUM. They are looking to raise $500m in 2014 and potentially another $500m in 2015 to replace the $1.3bn lost in FY12 and FY13.

CLIG also have another tailwind from the run-off of their marketing commission structure over the next 7 years. They currently pay £3.6m in commissions to marketing firms for introductions to clients they have however by 2020 this will have reduced to nearly £0 and the benefit should all flow directly to the bottom line. CLIG have also introduced nearly £1m of cost savings in the past year from closing underperforming products, reduced headcount and lower business development costs.

The other large negative factor weighing on the share price recently has been the departure of CEO and the FD under unexplained circumstances. It does appear to be fairly amicable however when Roger Lawson asked at the AGM no further explanation was given as to the reason behind it. It seems highly likely that due to whatever agreement was signed the board are unable to give the real reason for the departure. The question is what impact is this likely to have on the business? In the short term £1.1m had to be paid as termination fees to the departing management (although this was offset by Barry Olliff volunteering to waive his bonus) but the longer term fear is that this is sign of internal trouble within the staff – a very bad sign in a business that is highly dependent on the people it employs. This is partly offset by the fact that Mr Olliff believes that CLIG’s investment strategy isn’t dependant on ‘star managers’ but rather a ‘star process’, allowing internal talent to be developed. Also the firm’s focus (driven by Mr Olliff) on otherwise very good corporate governance and a pro-shareholder mentality offers reassurance, although this is clearly an area to be kept a strong eye on as prospective clients will want to see a solid investment team

On a valuation front, CLIG don’t ‘appear’ cheap as they trade at over 12x forward earnings (broker forecasts) however this is perhaps the wrong metric to focus on as earnings are volatile and the business is operationally geared. Given CLIG have the SWAD tailwind, the marketing run-off tailwind, the £1m cost-savings and are looking to raise ~$1bn of extra AUM over the next two years it seems likely that earnings could be significantly higher in 2-3 years time as AUM (and hence revenue) grows whilst costs come down. PTP margins are currently at 31% (a relative low) but have been as high as 41% previously and have averaged 34.2% since 2005.

Valuations for EMs also appear attractive and the case for EM investment is as strong as ever (See Wexboy’s excellent analysis) so it would not be unexpected to see a recovery in EM indices, further boosting AUM and earnings.

Investors are also paid handsomely to wait, with a 10% dividend at the current price (only just covered by earnings and probably uncovered next year, but 15.6% of the market cap is made up of cash on the balance sheet so CLIG should be able to maintain the dividend whilst earnings build back up). The wonderful thing about asset management businesses is that they are very high quality – earnings convert predominately in to cash and the business takes next to no capital investment in order to grow, so growth is highly value creating for shareholders. To confirm this, CLIG have earned an average of over 50% return on equity over the past three years. This lack of a requirement for earnings to be ploughed back in to the business means management have excess cash which can be distributed as dividends or used for acquisitions to expand the business (CLIG have tended to be more generous with the former, growing the dividend from 10p in 2007 to 24p today). It’s a great business to be in.


In conclusion, I think CLIG are both a great ‘value’ and ‘quality’ play (Stockopedia agrees with scores of 89/100 for Value and 88/100 for Quality) together with a number of favourable tailwinds and mean-reversion factors which should come through in the medium term, combined with top-notch corporate governance. I look forward to seeing them present at the next Mello event and highly recommend investors come and take a look at what I think is a great business at a great price!

An update on my portfolio since the last update: 


I've added SEA at 22.75p (yay!), NCON at 15p (yay!) and 3LEG at 24p (D'oh!). I bought more LCG at ~33p average price and topped up ZIOC at 15.6p as attractive prices presented themselves. I top sliced RNWH at £1.60 and TNI at £1.58, £1.72 and £2 as prices appreciated. I completely sold out of C21 for a big loss at 6.2p and out of JD. at £11.33 (too early, but at a decent profit) I've also bought one more 'mystery stock' I've blocked out of the list above as I'm still accumulating and it's a very illiquid stock. A full year review of my investment performance to come soon!

8 comments:

  1. Very nice analysis. My comments:

    -You say they are no longer paying for marketing firms. This seems odd considering they are trying to raise significant assets again due to client attrition. Do you know how reliable these firms were in the past for CLIG and how capable the firm's in-house marketers are? Even with great performance marketers are crucial to fundraising.

    -You think CLIG's strategies add alpha. EM Core is becoming a "commoditized" area of the emerging markets and without strong long-term performance clients will stay away, even if discounts are historically wide. Unfortunately performance chasing drives allocations and large institutions won't invest until the discounts narrow before they invest. Besides their recent struggles, are they at least 200-300bps ahead of the MSCI EM index over the long-term to justify a client hiring them?

    Thanks for sharing your analysis. You may not need either of these to matter in order to make an acceptable rate of return.

    ReplyDelete
    Replies
    1. Thanks very much for your comments, in response to your points:

      -I should probably clarify that I didn't mean they were no longer paying for marketing firms (I imagine they probably will have to for the $1bn they hope to raise - one to ask Barry at the Mello event), but rather that the trailing marketing fees for existing AUM are in run-off. Obviously how useful this is depends highly on AUM churn (and how they acquire new assets) but from the diagram in the latest annual report this appears to be relatively low (although this is an aggregated figure - another question for Mr Olliff to clarify).

      -With regards to their Alpha, they reveal their long term performance on this shareholder presentation (http://www.citlon.com/shareholders/share_reports/IP27.pdf) and their annualised performance since inception is 9.57% against 6.31% for the benchmark, so over 300 bp after fees. However, recent performance has been so poor that you do have to go back to 10 year annualised performance before they are ahead of their benchmark! This is largely a function of recent year performance being so bad as SWAD has expanded so significantly, killing their main source of alpha. If I were working in marketing for CLIG I'd be knocking together slides showing the correlation between SWAD and expected future alpha. You're correct that performance-chasing institutions (which is probably a worryingly large percentage of them, I suspect) won't be interested but the kind of client who would buy their argument is likely to be a good kind of client who can see past short term performance and think long-term and hence will be more likely to be a good, stable client. Again, this is another important area in general (how likely/easy do they think it will be to raise $1bn over two years?) so is another area I'll be quizzing Mr Olliff on.

      Delete
  2. On the basis of your analysis I bought 10k CLIG - now up about 800 GBP. What can I say, but thanks.

    ReplyDelete
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