Listed investment platforms that benefit from the move towards independent financial advice are among the few winners from the Financial Services Royal Commission.
The Commission’s shocking revelations on bank culture and financial-advice standards will surely strengthen the move towards independent financial advice – a trend that has been underway since 2013 Future of Financial Advice (FOFA) reforms.
More financial advisers will move away from bank-aligned distribution channels or large wealth-management firms and work for themselves. More customers, concerned about bank ethics, will favour financial advisers who demonstrate genuine independence.
Also, advisers will need to look for new ways to grow their business through technology. They’ll need tools that help them serve more clients efficiently, while providing a higher service standard. Technology that automates part of the process is key.
These trends are good news for listed investment platforms that Netwealth Group and Hub24 offer. Class is another beneficiary as more advisers and accountants use its leading administration software for Self-Managed Superannuation Accounts (SMSF).
I nominated Hub24 as a winner from the Royal Commission for The Bull in early May. Hub24’s share price soared from $11.58 to $14.79 since that story as the market reappraised demand for investment products and services offered through its online platform.
Chart 1: Hub24Source: The Bull
Hub24’s larger listed peer, Netwealth Group, has raced from a $3.70 issue price in a November 2017 float to $8.67 and is capitalised at just over $2 billion. Netwealth is one of the best floats in years as investors embrace the potential to increase assets under advice through its platform.
Chart 2: Netwealth GroupSource: The Bull
Class has rallied from a $1 issue price in a December 2015 float to $2.22, after posting a 52-week high of $3.65. Shares in the cloud-accounting software provider tumbled after its interim profit in February disappointed amid SMSF fund losses and rising client-acquisition costs. Chart 3: ClassSource: The Bull
Each stock has benefited from booming market interest in financial technology (fintech). The Royal Commission, in addition to quickening the trend towards independent financial advice, will make it harder for banks to stop insurgent fintechs taking market share.
Saddling banks with extra regulation and compliance costs could make them more vulnerable to technology-led disruption. Taking on tiny fintechs might be a lower priority for bank executives grappling with poor organisation culture, incentives and internal fraud.
Longer term, Netwealth, Hub24 and Class have good prospects as more advisers use their platforms and as SMSF growth continues. The challenge is valuation: investors might think they have missed the rally in Netwealth and Hub24 after soaring gains this year.
Still, chasing tech stocks sharply higher when hype abounds and there is an obvious short-term catalyst, such as the Royal Commission, rarely works. Portfolio investors should stand aside from these stocks for now, watching and waiting for an inevitable share-price pullback.
Experienced investors who are comfortable with micro-caps should put Class on their watchlist. It is approaching value territory after heavy price falls this year, but the market will want to see more confirmation that Class has overcome the loss of some key clients.
One of the market’s best small-cap judges, the Pengana Emerging Companies Fund, believes Hub24 could grow market share from less than 1 per cent of funds under advice through its investment platform to more than 5 per cent by 2025 on current growth rates.
Hub24 and Netwealth are attracting about 30 per cent of all new net fund flows into investment platforms, so it’s likely that both will have a significantly higher share of a large market. On Pengana’s modelling, Hub24 is trading on a single-digit PE in six years times if earnings grow as expected; a vastly different story to a PE of about 70 in FY19 on broker estimates.
It’s a reminder that basing investment decisions on simplistic valuation metrics, such as the forward Price Earnings (PE) ratio, misses the point. The best stocks usually have higher PEs for a reason: years of rapid earnings growth ahead that will lower the valuation multiple.
Pengana is known for backing high-PE stocks, when it believes in the sustainability of their growth, unlike other investors who are spooked by rising valuations and sell too early. This high-conviction style relies on taking a longer-term view of earnings growth.
Like other successful tech-based businesses, Hub24 and Netwealth can engineer rapid earnings growth for years. The bulk of investment is expensed upfront when the platform is built, meaning the marginal cost of adding extra financial advisers is low. The business is highly scalable and high margins should turn revenue growth into fat profits.
At the same time, the ageing of the Australian population and coming exit of Baby Boomers from the workforce add to demand for retirement investment products and financial advice. Greater supply of this service from a larger base of independent advisers who use tools and licensing services from independent platform is a certainty in coming years.
Again, the issue is price. Netwealth and Hub24 are ripe for a pullback given the magnitude of their rallies. Should it occur, a sell-off could be an opportunity for long-term investors who know that wealth management is a compelling business made even better through technology and adviser independence.
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article, consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at May 20, 2018.