Can iFAST survive a bear market?

iFAST’s current share price has been falling probably because of weak equity markets and concerns over higher costs related to their UK bank acquisition.

The current share price (SGD5) offers limited downside in my view and iFAST is a stronger and better platform because of its UK bank acquisition.

Here are the 3 reasons why I think there’s limited downside for iFAST based on the current share price:

1. iFAST is a stronger wealth management platform with higher switching costs
2. A UK bank differentiates iFAST international segments
3. iFAST’s current share price is already near a worst case scenario.

1. A stronger platform with higher switching costs

iFAST is viewed as a “bull-market stock” – meaning iFAST’s revenue and share price does well when overall share prices go up. This was true when iFAST was mainly a distributor of unit trusts. As a unit trust distributor, iFAST is paid a “trailer fee” or a percentage of the unit trust’s net asset value. Lower share prices lead to lower revenue. In 2016, iFAST’s net revenue and assets fell during a bear market as a result of lower trailer fees and customers selling their unit trusts.

iFAST is a more diversified wealth management platform now. The company offers cash accounts, stocks and funds. Offering a wider range of products makes customer’s assets more “sticky”, diversifies revenue and increases switching costs. Closing an iFAST account now would mean losing access to not just unit trusts but also stocks, bonds and attractive deposit rates. If a customer panics during a bear market and decides to sell their unit trusts, they have the option to invest in either bonds or cash deposits. Either option would generate income for iFAST. This resilience was evident in the first quarter of 2022. Despite falling equity markets, iFAST’s net revenue fell only 1% y/y and was flat q/q in the first quarter of 2022 while assets under administration increased 16% y/y and fell 2% q/q. These results were driven by the company’s efforts to diversify revenue and assets.

Consider the company’s revenue sources. Trailer fees made up 45% of net revenue in 2021 compared to 50% in 2018 while iFAST has 11 sources of revenue now compared to 8 in 2018.

2. A UK bank differentiates iFAST’s international segments

iFAST operates in Hong Kong, Malaysia and China with these international units facing fierce competition from local banks and wealth management platforms.

Offering UK deposits would differentiate iFAST from competing platforms while allowing customers to invest in the United Kingdom, a popular destination for Asian tourists and students.

Before the global pandemic disrupted outbound travel, China was the second largest tourism market for the United Kingdom (6% of UK tourism spend) in 2019 according to VisitBritain. China is the largest source of international students in the United Kingdom while Hong Kong was the fifth largest source of international students in the United Kingdom.

Adding a UK bank (iFAST Global Bank) to the iFAST platform will grow net interest income which is a counter-cyclical source of revenue. Higher interest rates typically lead to higher net interest margins and interest income which would offset the effect of falling share prices, lower trailer fees and trading activity . iFAST was able to achieve a 1.5% net interest margin in 2019 when global interest rates were higher than current levels.

Take a look at 2020-21. Interest rates fell globally which has led to iFAST earning net interest rates below 1% compared to 1.5% in 2019. Higher interest rates in 2022 should lead to higher net interest margins and interest income. Increased interest income could offset volatile equity markets and potentially lower trailer fees in 2022. iFAST is aiming to roll out an online bank account opening service in the second half of 2022.

Management is targeting only 1% net interest margins for iFAST Global Bank. This would involve a low-risk and asset light approach by transferring deposits to other banks which is similar to how iFAST currently manages its cash management business. In short, iFAST will not be making loans so credit risk will be minimal.

iFAST Global Bank is expected to incur SGD4 million of losses in 2022 but net interest income could eventually be a big part of iFAST’s revenue. A 1% net interest margin implies every SGD500 million of new deposits would generate SGD5 million of net interest income which would effectively turn iFAST’s UK bank profitable. I think aiming for SGD500 million of new deposits per year should be doable because iFAST was able to attract this amount in 2020 even without a UK bank. Investment platforms can usually generate substantial net interest income because wealth management usually begins with cash deposits.  For perspective, Charles Schwab generated SGD8 billion of net interest income in 2021 which was 43% of their net revenue. 

iFAST is using the Charles Schwab playbook. Charge low commissions to attract more assets while earning stable profits from net interest income on customer’s cash. A comparison with US platforms such as Charles Schwab shows that iFAST has plenty of room to grow net interest income. Ensemble Capital has a great way of describing Charles Schwab’s strategy:

“Schwab has increasingly shifted its customer monetization strategy from explicit fees via commissions and AUM based investment fees towards implicit fees based on opportunity cost of cash balances via net interest margins (NIM) at its Bank.

Therefore, Schwab wins over and retains customers with the lowest fees on the ~90% of their investment portfolio, thus accelerating market trends of declining AUM fees which is good for clients and a key decision point for them, while making money on the residual ~10% of their portfolio cash balance that is automatically swept into its Bank.”

 I previously explained how a UK bank would be a game-changer for iFAST’s wealth management business. The excerpt below is still valid:

First, depositing money into a bank account is the starting point for wealth management which typically results in banks being market leaders. Managing and understanding a customer’s cash deposits will allow iFAST to better cater to their wealth management needs (eg. offering bonds or a money market fund to customers with large cash deposits).  Second, iFAST’s Asian customers (particularly clients in countries facing capital controls!) would appreciate a bank account in the United Kingdom, a trusted jurisdiction and a global financial hub. Lastly, owning a bank, the “operating system” of the financial industry allows iFAST to streamline the entire wealth management process and brings them one step closer to their customers by managing their idle cash deposits. In short, a digital bank will allow iFAST to add customers globally at a faster pace.  

3. iFAST’s current share price is already near a worst case scenario.

iFAST’s share price is already implying a bear case scenario where the company’s Hong Kong MPF contract is cancelled, pretax profit from other segments remain unchanged from 2021 levels and minimal net interest income.

		Bear	Base	Bull
	2021	2025	2025	2025	Comment
Net interest income	4	14	22	34	1% net interest margin ($200m, $500m, $1B net cash inflow in worst,base and best scenario)
MPF contract	–	–	77	77
Other iFAST pretax profit	32	32	109	160	Base and best case includes MPF contract, worst case assumes MPF cancellation
Pretax profit	36	46	207	271
Taxes	(5)	(8)	(37)	(49)	18% tax rate
Net profit	30	38	170	222
Shares	287	302	302	302
EPS	0	0.1	0.6	0.7	1% dilution per year
PE	48	30	30	30
Share price		3.7	16.9	22.1

The huge MPF contract introduces revenue concentration risk for iFAST. If the contract is cancelled, one of the company’s major growth drivers disappears. But a cancellation is unlikely given the importance of the contract to Hong Kong’s pension system and iFAST’s pivotal role in operating the system. iFAST has previously executed similar projects on Malaysia’s pension system so execution risk should be manageable. Lastly, the current share price is partly pricing the risk of the MPF contract being cancelled.

In short, iFAST is a bigger and stronger platform now with a UK digital bank making the platform more sticky. iFAST’s diversified revenue model and interest income from the newly acquired bank should also reduce revenue downside. I will add to my position if iFAST’s share price continues falling.