Description
This writeup recommends selling short Man Group plc—the largest publicly traded manager of hedge fund assets in the world. Since the DJIA peaked in January 2000, Man Group’s stock has appreciated from 425p to 1450p as investors have flocked to the perceived ability of hedge funds to generate positive returns in all market environments. The stock currently trades for 20% of assets under management.
This writeup will argue that Man Group’s recent success is unsustainable for the following reasons: (1) Man Group’s track record—while reasonably impressive—cannot be maintained regardless of the market environment because of excessive asset growth that mathematically eliminates opportunities to generate significant alpha—given the outrageous layering of fees. (2) Institutional and retail investors’ obsession with hedge funds as the perceived asset class du jour—which is the main source of Man Group’s asset growth—is not sustainable. Within 2 to 3 years, Man Group plc should trade for approximately 580p to 700p per share—resulting in a 50% to 60% decline in the stock price.
Man Group trades on the London Stock Exchange and we were able to EASILY BORROW THE STOCK for a very reasonable incremental fee of only 50 BPS—standard for international stocks. To be clear, this excludes the short rebate based on an unspecified discount to UK base rate (4.75%) All amounts are stated in the appropriate currency. There are 308 million shares outstanding. The GBP / USD exchange rate is approximately 1.91.
Description and History: Based in the United Kingdom, Man Group is the second largest manager of hedge funds in the world behind UBS AG. Man Group manages USD $43 billion of assets under management as of March 2005—up from under USD $5 billion of assets when the global markets peaked in 2000. Approximately 60% of the investors are private investors, with 40% coming from institutions. Although Man Group manages a brokerage unit, hedge funds account for 85% of earnings; the Company is relatively unknown in the US because of its focus on European and Asian investors. Man Group also manages a futures and options brokerage firm that accounts for the remaining 15% of earnings.
After building a reputation as a commodity trading firm, the Company went public in a 1994. Since that point, Man Group has made two large acquisitions: first, Man Group acquired Glenwood—a US-based hedge fund manager and research firm in 2000 and second, Man Group acquired RMF Investment Management in 2002—a hedge fund manager based in Switzerland—for USD $833 mm or 10% of assets under management at the time and over 20x trailing earnings.
Man Group owns a hodgepodge of alternative funds including
Strategy Estimated AuM
AHL Managed futures $10 b - $12 b
Glenwood Institutional fund-of-funds $5 b
RMF Institutional fund-of-funds $18 b - $21 b
Other Managers Various strategies $5 b to $10 b
Total $43 b
Marketing: The marketing strategy is somewhat unorthodox for the industry. As opposed to keeping a low public profile like many large managers of alternative assets, Man Group makes a strong effort to promote its brand and different hedge fund products. Man Group has a large sales force and call-centers—supporting 2,700 employees in 15 countries and approximately 1,500 – 2,000 intermediaries. Instead of requiring a $500,000 minimum or more to invest in the funds, Man Group almost always accepts investors with only $25,000 and sometimes offers weekly and/or monthly liquidity. Approximately 12% to 18% of the assets turn over every year, according to the annual report. The percentage of total AuM from retail / institutional investors has increased to 56% / 44% in 2004 from approximately 50% / 50% in 2002.
In essence, a couple of timely acquisitions and a favorable macro environment have allowed Man Group to become the McDonalds of the hedge fund industry.
Weak Recent Performance Data: The performance of Man Group’s largest hedge funds has been extremely unimpressive; every single one of Man Group’s 10 largest hedge funds lost money as shown below in a difficult—but not overly challenging market.
9M Ending September 2004
S&P 500 +0.43%
Man-Glenwood Multi-Strategy -0.9%
Man AHL Diversified -7.9%
Man-Abritrage Strategy -0.5%
Man AP Unison Series 1 -4.1%
Man IP 220 Series Series 4 -5.7%
Man Global Strategies -4.6%
AHL Diversified Futures -5.4%
Man Multi-Strategy Series 6 -3.9%
Man Multi-Strategy Series 3 -4.6%
Man IP Plus Series 3 -6.1%
Man RMF Multi-Style -3.5%
We believe Man Group’s funds did recover in the latter part of 2004—but this is the most recent complete performance data released in the September 2004 interim statement. Man Group only publishes complete categorical data twice a year. Bulls may argue that Man Group had a temporarily lapse and their historical track record is more indicative of their ability to generate strong returns—but this thesis is flawed because asset growth impedes performance as argued below. I presume fellow VIC members may have better access to recent performance data—which would be greatly appreciated.
Too Big to Overcome Outrageous Fees: The largest issue for Man Group plc is the assets have grown too much to justify outrageous fees that are being charged to retail and institutional investors of hedge funds and fund-of-funds. After a typical hedge fund manager takes a 1% to 2% management fee excluding fund expenses and soft dollars (which likely constitute another 75 - 100 bps) as well as a 20% incentive fee, Man Group charges an incremental management fee of approximately 100 BPS and a usually charge performance fees of 5% or greater. As one can see, these fees start to add up very quickly.
In an increasingly crowded marketplace, this type of fee structure can only be justified if the returns are exceptional. As indicated above, Man Group was able to generate alpha in the past because they were smaller. However, Man Group is implying to retail and institutional clients that their impressive 13.1% net annualized return since inception on the flagship AHL Diversified Futures Fund is sustainable--which is unrealistic.
This writeup is not intended to discount the value-added proposition by small-to-medium sized fund-of-fund and hedge funds who have strict limits on asset growth and a desire to remain small and nimble to capitalize on market inefficiencies. If Man Group had $1 billion or $2 billion under management, it is highly possible that they could generate outsized returns.
As John Bogle, the founder of Vanguard said in a 2001 interview, “All investors over time get the market's return, before fees. After costs, though, the market is a loser's game by definition. The croupier rakes too much out…It seems to me inconceivable that you could take $500 billion run by 6,000 different hedge funds and expect those managers to be smarter than the rest of the world.” The fact is that Man Group has become a “closet index” for the hedge fund industry because of its size.
The fact is virtually no institution, hedge fund manager, fund-of-funds manager, mutual fund manager, etc.—no matter how smart they are—can generate strong enough returns with $43 billion under management to justify the “smorgasbord” of fees.
Janus All Over Again: At the end of the day Man Group’s rapid growth is most comparable to Janus Capital Group’s ascent in the mid-1990s and the subsequent rise in technology stocks. Both companies were beneficiaries of having a strong track record with a relatively small capital base for their respective strategies and reaped the benefits in the short-term of being the perceived asset class du jour. The analogy is striking and the following table shows the comparisons and should give one an idea of the magnitude of asset outflows and corresponding decline in shareholder value and brand equity that occurred with Janus and will likely occur with Man Group.
Janus Man Group plc
The Cataclysmic Event Netscape’s 1995 IPO Nasdaq’s March 2000 peak
Corresponding AuM Under $35 Billion Under $5 B
Peak AuM $325 B (2000 actual) $45 B-$50 B (2005 est.)
AuM After the Collapse $135 B (Oct. 2002) $20 B to $25 B (est.)
$134 B (March 2005)
Actual Decline in AuM 58% 45% to 50% (estimate)
Stock Price at Peak $54.00 1860p
Stock Price after Collapse $9.00 (bottom-tick) 580p – 700p (estimate below)
$14 (today’s price)
Market Cap at Peak $12.4 B USD $10.8 Billion
Market Cap after Collapse $2.1 B USD $2.9 Billion (€1.5 b GBP) (see valuation below)
To be fair, it is important to realize that Janus experienced not only asset withdrawals—but significant market depreciation as well. That being said, Janus funds declined so quickly that a lot of investors lost their principal before they had a chance to withdraw it. It is unlikely that Man Group would experience such large declines in their flagship funds—although use of leverage and illiquid securities can impair capital very quickly—despite so-called risk parameters, lack of directional exposure, diversification, etc. that clearly did not work for many hedge funds and fund-of-funds in 1998. In addition, it is interesting to observe that Janus has not grown assets under management since October 2002 despite an 80%+ rally in the Nasdaq.
Man Group’s Financial Results (GBP sterling) FY Ending March 31
2000 2001 2002 2003 2004 2005E
Hedge Fund Mgmt. PBT 56 71 118 181 271 305
Hedge Fund Perf. PBT 30 76 55 115 139 50
Brokerage PBT 27 12 30 48 70 79
Pretax Profit 113 159 193 296 434 435-440
Taxes 16 35 41 62 95 125
Net Income 97 124 152 235 339 310-315
Adjusted EPS (pence) 33 55 63 91 117 100-105
Assets Under Management 4.7 6.7 10.7 26.1 38.4 43.0
(USD, BILLIONS)
Current and Target Valuation: Man Group trades at a 20% of assets under management. This compares to a traditional valuation for money managers of no greater than 5% of assets under management. In addition, Man Group trades for approximately 14x trailing earnings—which would be a reasonable valuation for NORMALIZED earnings. However, we believe Man Group will lose around 50% of its assets within 2-4 years as stated above. At that point, Man Group’s earnings will collapse and the hedge fund division should trade at no greater than 10% of assets—which is still much higher than a traditional money manager.
Hedge Fund Valuation: The hedge fund division should have a trading value of USD $2 billion to $2.5 billion (€1.05 billion to €1.3 billion)
Brokerage Valuation: Assigning an industry-appropriate 12 P/E of after-tax earnings to the brokerage unit (assume it grows to €80 mm - €90 mm pretax, which is generous given many investors including us believe brokerage earnings are at the peak of the cycle) gets one an incremental €700 mm to €800 mm of value.
Price Target: This results in a price target of €1.75 billion to €2.25 billion or 580p to 700p per share.
Risks: Our field checks have suggested that the short thesis for Man Group has one principal risk. We have spoken to Man Group’s competitors and learned a lot about the business prospects. First, pension consultants and other institutional managers are still searching for capacity in the hedge fund business. Because so many of the well-known hedge funds are currently closed to new managers, our field checks suggested that we may be a little early and Man Group could continue to experience inflows. Our field checks suggested that Man Group’s track record and strong marketing arm DOES impress prospective investors who are unaware and/or ignorant of the fact that Man Group is not the same niche player it used to be; we believe this will become evident very quickly if returns do not improve.
However, there is a chance that Man Group manages to squeak by and generate sufficient returns to prevent large outflows. If the market is down significantly over the next few years and Man Group can generate positive performance, the inflows could continue at a strong pace. Furthermore, Man Group’s marketing arm could prove to be a competitive advantage over other hedge funds. If Man Group continues to gain assets, the market could place a high multiple on the earnings stream.
Disclaimer: We are currently short Man Group. Having said that, we may short more stock and/or cover the position at any time for any reason without notifying anyone. This is not an offer to buy or sell securities—so please do your own work and reach your own conclusion.
Catalyst
(1) Retail and institutional investors become less infatuated with hedge funds.
(2) Man Group’s rapid asset growth leads to inferior returns.
(3) Any credit crunch or liquidity crisis occurring.