Fears of recession are on investors’ minds right now and for good reasons. High inflation, rising interest rates, a conflict in Eastern Europe and tensions between America and China are threatening economic stability. However, how we feel and what the reality looks like are not often the same. Highlighting this difference between investors’ perceptions and hard data, investment bank UBS recently reported that some FTSE 350 companies are “quality but trading on recession discount”.
In my opinion, among these overlooked opportunities in the FTSE 350 is also the hedge fund business, Man Group (LSE:EMG).
Being one of the world’s largest active management firms, Man Group boasts one of the most resilient brands in the European alternative investment landscape, serving over 650 large institutional clients globally with an offering of more than 75 strategies. In total, Man Group manages just above $142bn in assets.
Throughout 2022, the stock has been trading between 250p and 175p, with the last close being at 243.30p at the time of writing. However, despite trading closer to its upper range, Man Group’s shares offer a couple of appealing qualities to investors seeking both capital growth and income from a solid equity business.
Let’s start with the latter quality: the income-generation capability. In this inflationary environment, everyone is looking for extra revenue streams. At the time of writing, Man Group’s shares offer an attractive 4.38% dividend yield. The two-year UK Government Bond (Gilt) yield is roughly 2.66% and the 10 year one revolves around 2.57%, in the context of a circa 10% inflation rate.
Unlike a Gilt, a business like Man Group can pass down the additional increase in prices to its clients by increasing its fees, therefore protecting the income it is able to deliver through its dividend.
Furthermore, the hedge fund business’s share price remains far below its pre-financial crisis levels. Given the huge demand for alpha from institutional investors, there is plenty of room for the share price to appreciate and deliver attractive capital growth for investors.
Bet on alpha?
Alpha is profit that can only be generated as a result of a fund manager’s skill — in other words, alpha only results if the fund manager beats the market. Man Group’s core business (the hedge fund one) revolves solely on this: to generate alpha for large institutions.
Ironically, its greatest strength is also Man Group’s most prominent risk: if the hedge fund business does not perform in line with its clients’ expectations, the underperformance may lead to less assets to manage in the future and thus to lower fees and, ultimately, to a smaller bottom line. However, the company has been successfully generating alpha for almost 35 years. This is the main reason behind its strong brand name.
Consequently, as an investor who is focused on the long term, I look at Man Group and see a high-quality FTSE 350 business trading on an attractive valuation, with a solid income stream that has plenty of room to deliver in the years ahead. I am strongly considering buying shares for my portfolio soon.