£1 trillion opportunity
There is a view that the boom in defined benefit (DB) transfers has been hugely beneficial to the flows of wealth managers – as well as helping IFAs’ revenues.
However according to a note from RBC Capital Markets the impact DB transfers has had on wealth firms has actually been underplayed.
‘We believe management have downplayed the role of such transfers in the surge in new pension inflows since 2014, due to worries that it be related to the 1988-1994 mis-selling scandal. We do not expect this to change,’ the note said.
RBC said the transfer market, which it estimated at nearly £1 trillion, is not likely to slow down.
The analyst said there are three businesses likely to see their share price benefit most from these transfers: St James’s Place (SJP), Brewin Dolphin and Rathbone Brothers. Their share prices ‘do not reflect the potential of the opportunity available’, the note said.
Read on for four reasons why RBC believes DB transfer flows are unlikely to slow down and how this could benefit the share prices of those three companies.
Regulation will not reduce flows
Given the raft of regulatory papers on DB pension transfer advice published by the Financial Conduct Authority (FCA) over the last year it is understandable that some people think the market will slow.
However RBC said the fact the regulator did not ban contingent charging in its final policy statement is good for the large wealth management businesses.
‘This is a sign that the regulator does not see any conflicts that arise from contingent charging as a major issue, in our view,’ it said.
The lack of ban is ‘good news for pensions transfer advisers who charge using this structure, which is a significant proportion’ according to RBC.
‘Most investors were unaware that there has just been a major FCA review, and as such, we do not expect any significant changes in the short-term,’ the note added.
Negative media coverage will not stop people transferring
Last year problems surrounding DB transfer advice given to members of the British Steel Pension Scheme prompted coverage from the national press.
Even though every news outlet from the Daily Mail to the BBC reported on the issues steelworkers faced, RBC said it did not expect a knock-on effect to harm the number of transfers.
‘Regulators and most industry participants are keen to avoid another mis-selling scandal, therefore limiting the likelihood of negative media attention in the first instance,’ it said.
RBC said that it thought we could see ‘a flight to quality’ in the transfer market. By this it meant clients will turn to bigger names such as SJP because they feel safer with a stronger brand name.
In fact the analyst said it believed established wealth managers were ‘less likely to provide unsuitable advice’ because they receive centralised training, and have guidance notes which reduce the likelihood of breaking rules and have a range of investment solutions they can recommend.
Smaller advice firms would argue that they also offer this, and arguably more choice given they are not restricted to a particular fund range.
Lower transfer values will not stop people from transferring
Transfer values have reduced since the Bank of England raised interest rates. Some people have taken this to suggest that fewer people will want to transfer out of their scheme, but not RBC.
It said it expects flexibility to be a much bigger driver of people transferring than large transfer values.
‘In our view, the large size of transfer values has added additional incentive to transfer, however, flexibility is the main driver of activity.
‘Further, while transfer values would fall in value when yields rise, it is likely that they will remain attractive for some time yet.’
There is not a ‘bubble’ for transfer volumes
RBC also claims the view that last year has seen a ‘bubble’ in DB transfer numbers is misplaced.
It said that in fact ‘we are just scratching the surface’ when it comes to transfers, as there is just under £1 trillion waiting to be transferred from DB schemes.
‘We calculate that as at 31 August 2018 there are £938bn of assets eligible DB assets. In 2017, £20.7bn was transferred from DB to DC, which is less than 3% of the current assets. We believe the trend of increasing transfers is therefore able to continue for at least the next five years.’
Read on for how the DB transfer glut may help the share price of SJP, Brewin and Rathbones.
SJP has emphasised it has a ‘cautious’ approach to DB transfers (and famously stopped advising British Steel members), but RBC said it is one of the wealth managers it expects to benefit most from the DB-DC trend.
SJP’s share price, like many other financial companies, has taken a hit in recent months and is currently at 1,036p per share (down from 1,240p in June). Its shares fell 4.5% last month after it reported a slight slowdown in its quarterly growth.
However RBC gave it a 1,120p price target based on a price per earnings multiple of 12 on its post-tax 2019 IFRS operating profit.
However the note did say there are certain ‘concerns’ that SJP faces, one of them being margin pressure.
According to RBC, SJP’s charge may come under pressure in light of the rise of US fund managers like Vanguard offering cheap alternatives.
‘If the charge reduces it is critical which component makes up the majority of the decrease. The biggest concern would be if the payment to SJP reduces. A 25 basis point (bp) decline in charge would have a significant impact on the SJP charge, reducing it from 100bp to 75bp.’
‘Other insurers may be able to offset pressure on charges by cutting costs; however, SJP—as a relatively new insurance company— does not have the same cost-cutting ability. In the most part, SJP cost reductions would come in efficiency savings.’
Brewin Dolphin does not offer DB transfer advice itself, but it is a big discretionary fund manager (DFM) which manages a lot of IFAs’ assets – much of which comes from DB transfers.
RBC gave Brewin a multiple of 17 to its earnings-per-share 2019 forecast given the firm’s ‘financial trajectory, momentum in the business and potential for sector consolidation’. This gives it a share price target of 425p – its current share price is 348p.
Wealth manager Rathbones has made a big push into financial planning in recent months and is also one of the biggest DFMs in the market – it manages just under £50 billion.
Its current share price 2,276p is also set to rise, according to RBC. The analyst note gave it price target of 2,800p, based on a 16x multiple of 2019 earnings-per-share forecast.
‘In our view, this multiple is appropriate given sustained sector rerating, current market levels and our belief that it appropriately reflects the company’s financial track record, growth prospects, premium brand, operational excellence and the potential for ongoing sector consolidation,’ RBC said.