Chief Executive’s Report
I am pleased to report on another year of progress towards our goal of becoming the UK’s leading advice-led wealth management company. Despite the disruption caused by COVID-19 and the impact that it has had on our clients, advisers and staff, the Company achieved both revenue and Underlying EBITDA growth whilst maintaining our Underlying EBITDA margin.
The Company continues to focus on the long-term needs of its clients and on reducing their overall cost of investing. Our clients entrust us to help them meet their financial planning objectives and we recognise that over a period of 20 years or more the cost of investing can represent a material cost compared to the original investment.
For this reason, the Company uses its size and buying power for the benefit of its clients. This was evidenced during the period as the growth in our segregated mandates further reduced the fund management charges to our clients and consolidated our position of providing a market leading client proposition.
The AFH business model remains underpinned by the culture that is encapsulated in our values. The Board recognises the multitude of stakeholders served by the AFH community and seeks to balance the interests of all stakeholders when implementing its business strategy. This was particularly apparent in the Group’s acquisition strategy, where an alignment of cultures has been proven to be fundamental to the integration and success of our acquired businesses.
New business revenues were significantly impacted during the second half of the year as uncertainty and the reduced opportunities for our advisers to meet and establish relationships with new clients combined to limit the amount of financial advice given and, in turn, the inflows of new portfolios. However, our continued investment in technology in prior years enabled our advisers to adapt quickly, maintaining contact with and providing ongoing services to existing clients. This was enhanced during the second half of the year by the roll-out of our client portal and wider dissemination of our technical and investment updates to our clients through digital media.
New business in the protection division benefitted from an initial surge in public interest in life and critical illness insurance. This was, however, tempered in the final quarter as cancellation of policies taken out at the height of the national lockdown was higher than usual as the perception of the likely spread and severity of COVID-19 changed following the government’s relaxation of restrictions.
Notwithstanding the above, new business levels in the wealth management division slowly increased during the latter part of the year and, whilst not returning to pre COVID-19 levels, the trend gives us confidence for the new financial year and the anticipated need for professional financial planning as the economic and fiscal impact of the pandemic is transmitted through society.
Recurring revenues increased during the period in spite of the market downturn at mid-year and again proved our investment approach across the various attitude to risk investment models. Recurring revenue accounted for 78% of total revenue in the wealth management division, an increase from 72% in 2019.
The Group strategy to increase shareholder value through the expansion of the AFH community remains at the heart of AFH’s growth. While in 2020 the Company withdrew from the acquisition market in order to consolidate its previous growth and to strengthen its balance sheet through the reduction of outstanding debt and contingent consideration, our strategy of combining organic growth through greater productivity of our advisers together with value accretive acquisitions financed on an earn out model remains unchanged. The financial success of our strategy is monitored regularly by the Board against KPIs and is measured against the three key aspirational targets set by the Board in 2019.
Culture is at the centre of any successful organisation and remains the driving force of both our internal growth and acquisitions. Our values, which are detailed in the Annual Report, have been documented to ensure that we are able to measure our progress and achieve both our vision and
Central to our strategy is to put clients’ interests first to build a sustainable business that reflects our vision, including a drive to reduce the cost of ancillary third-party services for our clients and to embrace them in the AFH community. During the year, we continued to to reduce third party fees to provide a market leading client proposition while retaining our status as independent financial advisers, providing access for our clients to the market at institutional prices.
Despite the impact of COVID-19 on the business and the temporary withdrawal from the acquisition market, the year under review produced a seventh consecutive year of revenue growth and improved profitability since joining AIM in 2014. Increased revenues and tight control of our fixed cost base enabled a stable statutory Earnings Per Share at 25.0p while underlying Earnings Per Share, excluding the benefit of IFRS 16, increased by 4% to 34.1p.
Total revenue for the 12 months ended 31 October 2020 of £77.1m was 4% above the corresponding period (2019: £74.3m) reflecting the resilience of the business in extraordinary times.
The continuing requirement of our clients for financial advice and protection insurance generated £29.8m (2019: £28.3m) of new business revenues, while recurring income of £47m (2019: £46m) continued to demonstrate the strength of our revenue base and earnings quality.
Our retention of existing clients and their investment funds continued to be high with outflows, including pension drawdown, remaining at 3% of opening funds under management.
Gross margins declined in our protection business during the year following the strategic change in product mix. This reduced the divisional gross margin to 37%. While the gross margin of our Wealth Management division remained constant, at a consolidated level the protection division change reduced the overall gross margin from 53% to 50%.
During the year we were able to increase our Underlying EBITDA and to maintain our Underlying EBITDA margin above 23% (2019: 23.2%) despite the reduction in the gross margin caused by the revised mix of business in the protection division and the impact of COVID-19.
Interest charges increased during the year as the 12-month impact of the 4% CULS was recognised and the Company drew down the HSBC facility at a net annualised cost to the business of 1.75%.
Profit after tax for the year of £10.7m (2019: £10.8m) confirmed the resilience of the business and enabled the Company to maintain its dividend during the year whilst maintaining appropriate cash reserves throughout the year. Statutory Earnings Per Share remained stable at 25.0p (2019:25.4p). Underlying EBITDA, adjusted for tax per share, being Underlying EBITDA less a current tax charge at 19%, is a key measure used by the Board which reflects the cash-based Earnings Per Share generated by the business. This increased slightly to 34.1p (2019: 32.8p).
Investment in Technology and Digital
For many years we have seen increased technology supporting our face-to-face advisory model as fundamental to the future of our business and have consistently invested in technology both operationally and for the benefit of our clients. The events of 2020 demonstrated the value of this strategy. 2020 was a year of further investment, with over £1.5m expensed as we targeted long term operational efficiencies and a streamlined experience for our clients in addition to supporting our staff and advisers working remotely.
In addition to supporting over 300 staff and our IFAs to work remotely from our offices, 2020 saw the launch of our client portal and an increased focus on digital marketing. We will continue to build on these and new technology solutions in the future in order to enhance the support provided to our advisers and services offered to clients. We are also currently looking at offering cyborg advisory services to provide greater flexibility in our interaction with existing and potential clients.
Our marketing strategy continues to embrace the digital opportunities for the sector. For a number of years, the Group has invested in establishing a marketing capability to support a growing national business and to extend beyond the traditional IFA routes to market. While we believe that face-to-face advisory remains the best model to serve clients’ needs, our evolving digital approach has already started to expand our target market and to provide benefits to individuals and corporates who join the AFH community.
We believe that our approach to technology, together with our focus on reducing third party costs for our clients, will provide clear commercial advantages for our clients and advisers and enable AFH to benefit from further consolidation in the market, generating significant shareholder and client value in the future.
Review of investment climate in 2020
The year was a rollercoaster ride for investors, dominated by the fallout from the COVID-19 pandemic and policymakers’ responses to it. The period started well enough, with markets buoyed by a victory for the Conservative Party in the December 2019 UK general election, the avoidance of a ‘no-deal’ Brexit and the signing of the US-China ‘phase-one’ trade deal in January. However, as the pandemic spread from China to the rest of the world, the introduction of stringent lockdown restrictions resulted in an unprecedented contraction in the global economy during the spring. Although the lifting of lockdown measures ushered in a sharp rebound during the summer, most major economies – with the notable exception
of China – ended the period with economic activity still well below pre-pandemic levels.
While the disruption wrought by the pandemic was unprecedented, global policymakers’ responses to it was also on a scale never seen before. Governments around the world spent in excess of US$10 trillion on various relief measures – such as furlough schemes, benefit top-ups and loans – to support households and businesses. Meanwhile, central banks cut interest rates, injected liquidity into markets and restarted quantitative easing (QE, or bond buying) programmes.
These interventions served to underpin financial markets. Despite the huge increase in borrowing, yields on developed market government bonds hit record lows as central banks committed to buy vast quantities of debt, and investors anticipated that official interest rates would stay close to zero for years to come. Amidst speculation that the Bank of England would at some stage take interest rates below zero (a fate which has so far been avoided), yields on short-dated UK government bonds spent much of the year in negative territory. As bond prices move inversely with yields, Gilts delivered solid single-digit returns over the period.
In turn, ultra-low government bond yields boosted the relative appeal of other assets. The combination of negative ‘real’ (i.e. after inflation) bond yields and the uncertainty created by COVID-19 helped push the gold price to a record high of just above US$2000 per ounce in early August. Despite a subsequent pull-back, gold still notched up a gain in excess of 20% over the year.
The liquidity injections from central banks also spurred a turnaround in global equity markets. After a positive start to 2020, the mood amongst equity investors turned sour towards the end of February as the ramifications of global COVID-19 lockdowns became clear. Between 19th February and 23rd March, global equities (as measured by the iShares MSCI ACWI ETF) fell nearly 34% – the fastest drop ever recorded. However, supported by record monetary and fiscal stimulus, the bounce back was also extraordinarily swift, with the broad global market regaining its prior peak at the end of August and recording a gain of around 4% over the 12-month period.
However, this headline performance masked a wide divergence between regions and market sectors. With lockdowns accelerating the move towards ‘online living’, the big tech companies that profited from this trend (e.g. Amazon, Microsoft, Netflix etc.) led the market higher. As a result, the US equity market, home to most of these tech titans, outperformed and returned nearly 10% during the year. Chinese equities benefited not only from a high exposure to the tech/online sector, but also from Beijing’s relatively successful containment of the virus and the subsequent ‘V-shaped’ recovery in the Chinese economy. As a result, Chinese equities outshone other major markets during the period, rising more than 30%.
A relatively high exposure to underperforming sectors and a low representation of companies in the tech sector meant that UK equities were one of the worst-performing markets during the year. Despite relatively generous government support for households and businesses, the UK experienced a worse economic contraction than its developed market peers. Deep cuts to dividends took a heavy toll on a market whose income-generating qualities have historically been a key attraction. By the end of the 12-month period, the broad UK equity market was down more than 20%. The disappointing performance of our domestic market highlighted the importance of a diversified portfolio, both in terms of asset class and geography.
Financial advisory and investment management
Financial advisory, and the ongoing investment management of our client portfolios, represents the core business of AFH. Likewise, the management of our clients’ funds is driven by their attitude to risk on the basis of long-term investments that are measured against the equivalent ARC Private Client Index (“PCI”) and reported regularly to our clients, providing the opportunity for them to measure our investment performance in the context of a range of discretionary investment managers.
The average discretionary portfolio managed on behalf of our clients continues to be approximately £200,000 of investable assets, the construction of which is primarily based on a client’s risk appetite and focused on wealth preservation. However, for clients with larger portfolios who wish for a more traditional stockbroking service, AFH Private Wealth was established in 2016 and now manages over £250m of client assets, operating from Bromsgrove and Colwyn Bay.
During the period we have grown our employed adviser base to complement the already established self-employed adviser model. This strategy has allowed us to broaden our appeal in the IFA market and recruit in a challenging market where demand continues to exceed supply. While having no financial impact on the year under review, this strategy has enabled the Company to enter 2021 with a strong pipeline of employed advisers who are scheduled to join AFH in the first calendar quarter of 2021, providing a significant boost to our capacity and geographic penetration at a time when the need for professional financial planning is expected to be at exceptional levels.
During the year, our initial financial planning fees totalled £12.7m (2019: £15.1m, reflecting the challenges faced by our advisers during the year as highlighted above. Ongoing management fees increased to £47.3m (2019: £43m), in spite of the markets, which spent much of the year below prior year levels, and the modest levels of net inflows from new and existing clients. This increase was reflected in the ratio of recurring income to new business within this division, which increased to 78% for the period.
Employment costs remain the major fixed cost of the division, accounting for over 80% of all fixed cash expenditure. During the year, all of our staff agreed to a temporary salary reduction in the light of the uncertainty as to how the business would be impacted by the COVID-19 pandemic. In asking staff to make this sacrifice the Board considered the short-term effect of the 2007 financial crisis when over 60% of new business was lost in the period following the initial crash and I echo the thanks of the Chairman to all of our staff for their action. I am also pleased to report that the full impact of the reduction was only applied for three months and all staff were returned to their original salaries in September 2020.
As noted above, the division invested heavily in IT and marketing initiatives during the year which enabled it to maintain a full service to our clients throughout the year. The digital marketing drive, which was launched in June 2020, showed significant promise with the cost per lead and conversion rates both in line with the Board’s expectations, based on the marketing studies undertaken prior to launch. Whilst the project remains at an early stage and the full revenue benefits of this new channel to market are not apparent in the 2020 results, we are pleased with progress to date and the initial results and will continue to monitor closely. Notwithstanding this increased cost, the division generated an increased EBITDA of £16.5m (2019: £14.2m), representing a 28% margin on revenue (2019: 24%).
Strategic Business Model
As outlined in November 2019, during the period the focus of this division was on cash generation and the maintenance of the working capital requirements from the Company. This was anticipated to reduce the gross margin significantly from the 54% level reported in 2019 as the ratio of indemnified vs non-indemnified policies written moved significantly in favour of the former.
Our face to face protection broking business, Eunisure, enjoyed a strong first half continuing to perform well during the initial lockdown in spring 2020 when demand for protection products increased across the sector as the public became more aware of the dangers of remaining underinsured.
The fourth quarter of the year saw a fall in demand for new protection insurance and a number of policies taken out during the initial stages of the pandemic cancelled as public confidence increased with reduced government restrictions. Notwithstanding the somewhat turbulent nature of the year the division was able to increase revenues to £17.1m (2019: £14.2m).
The division generated EBITDA of £4.6m (2019: £5.4m), representing a 27% margin on revenue (2019: 38%), reflecting the decreased gross margin following the strategic change in the product mix of this division.
As reported in 2019, in assessing its financial gearing, the Board considers the structure of the AFH acquisition model with over 50% of the maximum consideration to be deferred and subject to performance criteria as a component of the Group’s financing structure. In November 2019 the Board decided to reduce the overall level of gearing by the reduction of the contingent consideration balances, which at 31 October 2019 totalled £37.9m, and by using its trading cash surplus and banking facilities to repay the 8% Loan Notes that matured in September 2020.
The Group continues to maintain a strong cash position and, furthermore, all regulated subsidiary companies reported significant margins above their regulatory and stress-tested capital requirements as at 31 October 2020.
As noted in the Chairman’s Statement, in March 2020 the Company repurchased a portion of the 4% CULS, issued in August 2019, at a discount of 13%. As at 31 October 2020 there remained £13.6m CULS outstanding, convertible at a price of £4.20 per share and maturing in August 2024.
At the year end, the Group had a maximum £19.3m of contingent consideration outstanding over the next three financial periods, subject to performance criteria, together with £13.6m of CULS. Based on past performance it is unlikely that all of the contingent consideration would become payable.
Current year trading
Trading in the initial months of the current year continued resiliently in the face of continued uncertainty. In the coming months we expect our strong pipeline of newly employed advisers to join the firm, providing us with a significant boost to AFH’s advisory capacity and geographical reach at a time when we see the demand for professional financial planning growing significantly.
As reported even prior to the pandemic’s impact on global markets, 2020 was to be one of consolidation for AFH and we are extremely pleased to have finished the period with a strengthened balance sheet, significantly reduced outstanding contingent considerations and strong cash balances.
Trading remains in line with the Board’s expectations and the resilience shown throughout 2020 and in the first months of the new financial year leaves us confident about the year ahead.
Chief Executive Officer
15 January 2021
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