Anyone watching the row between the management of Alliance Trust and its single largest shareholder, Elliott Advisors, must be wondering where this is all going to end. (You can read all about it here) I’m no expert in corporate governance but I wonder if this raises a few due diligence questions for advisers on ATS, the Trust’s platform business and on platforms in general.
One of the specific concerns cited by Elliott for wanting a change at board level is ‘the continuing losses in the Company’s two operating subsidiaries, adding to the total costs borne by shareholders.’
One of the subsidiaries referred to here is Alliance Trust Savings, the Trust’s platform business. For the first time in 8 years, ATS made a profit for in 2013, largely because it sold its full SIPP business earlier that year. In 2014, ATS decided to outsource its technology to GBST, costing more than £2million and resulted in loss before tax of £3.3million. ATS has a £30million hole in its P&L reserve, a result of accumulated losses over the years.
Now, here’s the question; if shareholders are worried that the platform business is loss-making, should advisers placing clients’ assets on that platform be equally concerned?
We think so and this is a point we made in our Guide to Platform Profitability 2014;
The platform business is very capital intensive with very low margins and, if a platform is running up losses, advisers need to ask tough questions about when they can expect it to become profitable. Failure to do so could see advisers sleepwalking into a major crisis in the future. And if a platform keeps moving the goal posts as to when it’s likely to become profitable, advisers must wonder if the business is not viable or if the management simply has no idea of what they are doing. Without profits to reinvest, advisers can expect systems to start to creak and fall over, human error will increase and service levels will drop — unless of course the platform can call on its deep-pocketed parent to bail them out. But that’s only a short-term fix. The worry for advisers should be this: will rich Mom and Pop continue to bankroll their spoilt kids?
If we agree that ATS’s primary purpose is to contribute to the Trust’s bottomline and it has hitherto failed to do so, how much longer will shareholders continue to tolerate the level of losses for? How much longer before the board decides to pull the plug?
The point here is this;
We have to put the platform business as an entity under greater scrutiny. And this isn’t just an issue for ATS, many platforms owned by parents with deep pockets are in similar position.
AuA Is Vanity
AUA is another superficial way advisers use to judge how well a platform is doing, but AUA growth must translate into bottom-line profit or it’s futile. There’s so much emphasis in the platform sector on gathering and growing assets that the bottom line neglect is now painfully obvious.
ATS currently has around £7bn under administration and it can’t seem to turn a real profit; what asset size does it actually expect to be able to do so? Without profits, where is future investment in service and technology going to come from? And is the parent company (its board & shareholders) committed to continue plowing millions of pounds into their loss–making platform?
You might be wondering ‘what’s a reasonable timescale and asset size for a platform to become profitable?’ Going by the experience of other players in the market, we think £5billion AUA and 5 years of entering the market is reasonable. Clearly ATS lags many of its peers in the regard and advisers on the platform need to be asking the management some touch questions.
Fixed Fee Mode: Strength or Weakness?
ATS is forever banging on about the fixed fee model being its core strength, but this is a double-edged sword. ATS fixed pricing model means it has one of the lowest yield on asset in the platform sector – around 0.20% and this continues to fall. While a fixed price model may be a good way to stand out in a crowded market, it presents a number of challenges in terms of profitability and resilience of the business. It means that a firm’s revenue and profits are not directly linked to its AUA; the firm don’t benefit directly from asset inflows and stock market growth from existing clients on the platform. To improve revenue, ATS has to find more clients, which is expensive and encourage existing client to trade more (often, this the exact opposite of what they should be doing).
Of course, this means that the ATS doesn’t have the risk of losing revenue when markets fall, and may benefit from increased trading fees during volatile market conditions. However, it is fair to say that, overall, markets tend to rise more than they fall — otherwise there is no reason for anyone to invest or for the entire investment industry to exist. The upside of AUA-based pricing outweighs the downside, and ATS’s fixed pricing model places some constraints on its long-term viability that the other platforms don’t have. It simply means that, if you want to improve profitability in a world of fixed price models, you’re going to have to raise your price or find more clients!
So where does this leave us?
Platforms are real businesses, not some theoretical IT concepts and we need to approach them that way. Unlike hygiene factors such as price and functionality, proper due-diligence is rarely black and white. It requires a dispassionate look at the strengths and weaknesses of the platform, asking difficult questions about its long-term viability and making an informed decision as to whether you’re comfortable with the picture in front of you.