U.K.-based Tatton Asset Management (LSE:TAM, Financial) may be a lesser-known name to most investors, but in serving the niche segment of Independent Financial Advisers (referred to as “IFA”), the company earns its leading position of “selling picks and shovels.” It provides products and services that are designed to enable its clients, IFAs, to advise their end clients – for instance, on-platform only discretionary fund management (referred to as “DFM”) services through its namesake investment management division (roughly 75% of the fiscal 2020 sales) as well as regulatory, compliance, business consulting and mortgage services through the “Paradigm” division (25%).
With his knowledge, experience and resources, serial entrepreneur Paul Hogarth established Paradigm in 2007 with the goal of developing a range of services to power the U.K.’s IFAs and the strategic focus on enabling them to better serve their clients. The “Tatton” investment management was soon added as a subsidiary of the group and grew rapidly to become the most significant revenue contributor. The business went public in 2017. Fast-forward to today, and the founder remains as the CEO of the company with an almost 19% equity stake. Prominent value investors in the stock include Liontrust Investment Partners and Sanford DeLand (the parent of the Buffettology Fund).
Browsing through the recent-year financials since the initial public offering, one can easily sense the robust business fundamentals at Tatton Asset Management. Over the past three years, the return on equity ranged between 28% and 51%. Meanwhile, the sales, operating income and earnings per share increased annually by 22%, 32% and 89%, respectively. The growth has been consistent at a double-digit rate every year. The cash conversion averaged 1.04 times. Operations have been quite asset-light, consuming less than 5% out of sales typically. Currently, there is no debt and plenty of liquidity (a 2.5x current ratio) on the balance sheet.
In spite of the quantitatively high quality of the company, the share appears to be trading at a reasonable valuation: e.g., a trailing price-earnings ratio of 19.3 compared with 25.8 in 2018 and 30.8 in 2019, or a price-cash flow of 18 times compared with 25.5 in 2018 and 33.7 in 2019. Hence, we became intrigued to dive deeper into business economics at Tatton Asset Management to gauge the durability of such a strong performance.
When it comes to the investment management business (three-quarters of the entire company with a higher margin), Tatton solely concentrates on providing discretionary management of mutual fund-based portfolios exclusively to U.K. WRAP platform-based clients. The business does not offer its services directly to retail clients, but instead, operates as a supplier for IFAs, avoiding potential conflicts of interest or competitive threat to advisor-client relationships. The investment approach at Tatton primarily involves modeled portfolio rebalancing and tactical asset allocation with the objective to consistently achieve returns commensurate with the risk profile of the retail clients, unlike active fund managers who need to generate alpha (which is a much tougher job in our view).
Tatton is now the largest on-platform DFM provider in the U.K., offering substantial economies of scale. The resulting low cost of the services (i.e., an annual fee of 0.15% versus 0.24% to 0.75% at its major peers) becomes not only the main attraction to retail clients, but also a significant source of the moat – according to the management, newcomers to the niche are potentially reluctant to commit to initial cash burn and established players are typically unwilling to bear the cannibalization risks. We notice that the assets under management at Tatton almost double the one at the closest competitor in the space.
Despite the market-leading position, Tatton still manages to grow at a decent rate. The assets under management increased 9.6% in fiscal 2020 (ending March 2020) even against the backdrop of the global market panics. At the same time, the number of firms and accounts utilizing the company’s DFM services increased by 33.7% and 13%, respectively. As you can imagine, most of the revenue at Tatton is recurring and predictable, including the more “legacy” Paradigm business, which charges monthly membership fees to a loyal client base (the average membership lasts more than six years). It appears as if the current momentum will not stop anytime soon thanks to the trendy growth in both on-platform funds under management (referred to as “FUM”) and the DFM portion. Furthermore, Tatton only captures less than 14% and 11% of the total on-platform DFM FUM and overall directly authorized IFA market in the U.K., per our calculation.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.
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