Is the ‘millionaires factory’ about to increase shareholder returns?
Macquarie Group (ASX: MQG) has earned its nickname by richly rewarding its executives through a high compensation ratio that some believe favours employees over shareholders. Now it seems that could be changing, with the balance starting to tip back towards shareholders. But does that make Macquarie a buy?
As value investors, we must understand where the underlying value of a business flows. Does it go to shareholders, management, employees or third parties? Investment banking is one service industry where shareholders are likely to share excess returns with employees. But could this be changing at Australia’s ‘Millionaire Factory’?
Macquarie Group (ASX: MQG) has a policy of linking employee compensation to excess returns, but the actual compensation formula has never been disclosed. Jonathan Mott at UBS has done some excellent work regarding this compensation ratio, and argues that it may decline over time. Having done our own research on Macquarie, we tend to agree.
Macquarie Group has changed dramatically over the decades. Its Capital Markets division only comprises 30 per cent of group income, and it now has greater interests in asset management, mortgages, leasing and credit investments. As such, we actually see Macquarie Group as an asset manager with an investment banking arm, though the market may still see the inverse.
The Asset Management division comprises the largest share of income and profit, yet its compensation ratio is relatively low, which means that should the division continue growing strongly the Group’s compensation ratio should fall (but we appreciate that bonuses are still highly discretionary).
Macquarie has also had a magic run in the past two years, with a weakening Aussie dollar, a strong IPO pipeline, and impressive performance fees helped by a low interest rate environment. Macquarie’s income outlook appears weaker than in recent years, which means that management may be inclined to reduce compensation to support earnings (particularly given how much the wealth of their top executives is tied to the share price).
If the compensation ratio does continue to decline at Macquarie, the market may come to share our view that more of Macqaurie’s returns could accrue to shareholders than employees.
But while the stock has sold off materially since Brexit, we would still need the price to fall even further to warrant investment.
Ben MacNevin is an Analyst with Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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James
:
Thanks
James
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Hi Ben
Do you have any numbers on the movement in compensation ratio at Macquarie? Is it enough to move the needle that it will make a meaningful difference to shareholder returns?
At Macquarie I thought the biggest driver of returns would to be the top line. Operating income can be quite variable due to a number of factors and looks to drive shareholder returns a lot more than the costs.
For example can performance fees in the asset management division be repeated? The funds that are realising assets and earnings performance fees seem to be benefitting from a once in a lifetime fall in global interest rates which has increased the price for infrastructure assets that they are selling. Conversely any assets currently being purchased by the infrastructure funds will be at current elevated prices which will make it harder to outperform in future and impact future performance fees.
Also would you be concerned by Macquarie’s mortgage portfolio and potential loan losses? Roger has been warning about oversupply of of apartments in the next 12-18 months that could lead to a downturn in property prices. Macquarie has been late to the party in respect of increasing its amount of mortgage lending in Australia. This likely makes Macquarie’s mortgage book more exposed to potential loan losses as Macquarie has done more of its lending recently at higher property prices.
Ben MacNevin
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Gday James,
Macquarie presents the compensation ratio in their financial report – it’s currently 39% of income, so it’s a material determinant of returns. My argument in this post is that if Macquarie continues to grow the Asset Management business over the Capital Markets business, then the Group’s compensation ratio should decline. However, management has a high degree of discretion with this line item, which means they can use this lever to manage the Group’s returns.
Regarding performance fees, we think it’s unlikely that recent performance fees are repeatable, and management has also guided for lower performance fees at the half year. You are right though – the funds are benefiting from higher asset prices through a low rate environment.
Regarding mortgages, higher impairments are certainly a factor to be mindful of, but this division only comprises ~15% of Group income, and contributes even less to profits. The real value in Macquarie lies in its potential to scale its Asset Management business – keep that in mind if the property market does turn and Macquarie attracts a lot of negative headlines, as the market may miss the bigger picture.