Neil Hennessy occupies the most embattled quarter of the fund industry, and that suits him just fine.
This month, Hennessy marks his 40th year in the active-management business. His publicly traded company, Novato, Calif.-based Hennessy Advisors (HNNA), manages 14 mutual funds—no separately managed accounts, no institutional accounts. And even as low- or no-cost exchange-traded funds and other passively managed products grab market share and attention, the firm keeps acquiring more funds—most recently two from BP Capital Advisors, which was founded by T. Boone Pickens.
The firm’s largest fund is the $2.5 billion Hennessy Focus (HFCSX), which has decent performance but, like the Hennessy funds in general, carries higher-than-average fees: 1.50%, versus the category average of 0.84%. The fund Neil Hennessy personally manages, Hennessy Total Return (HDOGX), invests in the highest-yielding stocks in the Dow. While it has done well against peers, it also has high fees, 1.58%, versus 1.20% for the category average.
We checked in with Hennessy about his take on the market, his outlook for active management, why his firm’s shares have such a low price/earnings ratio, and why he doesn’t just get out of the business.
Q: You active managers face no shortage of headwinds, most recently the low-fee, no-fee scenario.
A: Yes, everybody is buying into the story that low fees are the best for the client. God knows what will happen with the fiduciary rule. Then there’s passive versus active. All that combined makes a lot of asset managers like us, in my opinion, very undervalued.
In this marketplace, active will win out over time, because all these ETFs and S&P 500 index (.SPX) funds own the same thing and the same percentage of the same companies. In a selloff, the selling will beget more selling and everybody will sell the same thing. That’s when the value managers will win out, because they are buying individual stocks, not just the S&P 500.
Nobody pays particular attention to the asset-management industry. But if the market goes up 10%, [asset manager] assets go up 10%. We don’t need more office space, employees. My four biggest costs are variable—third-party transaction fees, compensation, sales, and subadvisory fees. That is different from a company stuck with real estate and fixed costs. If assets come down, your costs come down. We have 325,000 mutual fund shareholders. We manage $6.4 billion. We do this with 21 employees. And we sell at seven times earnings. The publicly traded asset managers have a P/E of 13 on average.
Q: Well, your market cap is $113 million.
A: When you look at it, our Ebitda [earnings before interest, taxes, depreciation, and amortization] as a percentage of revenue is 45%, compared with 30% for the industry. Earnings per share have more than tripled over the past five years. But [no investment bank] is going to cover your stock unless you do a transaction with them.
Q: Really? You’re always acquiring things.
A: Yeah, but we use either cash or debt. We don’t do any investment banking.
Q: Isn’t your growth under pressure because of the high fees on your funds?
A: Our growth is predicated on two things: organic growth and acquisitions. There will be more acquisitions coming up. We are only in the mutual fund business. We understand it. At the end of the day we’ve made clients money each and every year. It doesn’t matter if you keep up with the indexes, in my opinion, because at the end of the day clients just want to make money.
Q: Will you be cutting your fees?
A: No, there is no reason to. It is not good for shareholders of either the mutual funds or shareholders of Hennessy Advisors if I go out of business. We get paid a management fee of 40 to 90 basis points. [A basis point is 1/100th of a percentage point.] People get that mixed up with the total expense ratio, which includes administration, custodial, transfer, the SEC fees, regulatory fees, accounting fees. Out of our management fee, we have to pay some of the third-party platform fees.
If I’m only charging 40 basis points and Schwab, Fidelity, or other third-party platforms are charging 40 basis points, how do I make money? I ran the numbers and our shareholders are better off [with us] losing half our assets than capping our fees. Private asset managers are capping or waiving fees to attract assets or save them. That hasn’t worked, because in passive versus active, you don’t get in the middle of the train tracks when the train is coming.
Q: Why do you even stay in this business? Is Hennessy Advisors part of a different, larger firm in the next 10 years?
A: I’ve been in business for 40 years. I like to make people money. If somebody wants to buy us, that’s fine. We’re open. I told the shareholders when we went public in 2002 that we were building this company to sell. But if somebody wants to buy me at seven times earnings today, that’s not in the best interest of the shareholders.
Q: Where are the opportunities for people acquiring mutual funds today?
A: We’re in the middle of buying two BP Capital Funds, run by T. Boone Pickens’ firm, to complement the Hennessy Gas Utilityfund (GASFX). We’re always looking. Half our assets have grown organically and through market appreciation; the other half have grown through asset purchase agreements. We want to make sure any deal is good for our mutual fund holders, good for the company shareholders, good for the company. I talked to a mutual fund company and said, “I can’t acquire you because you waived all your fees, so I can’t be profitable. Until your board decides to give up the waivers, which would be next March, then we can talk. I can’t buy your fund and cut my own throat.”
Q: Let’s talk about other cheap companies, not just Hennessy Advisors.
A: Winnebago Industries (WGO) has a low price-to-sales ratio, great earnings, and a dividend that definitely can be raised. They just bought Chris-Craft. You can buy a vacation home for half a million dollars, or a motor home for a couple of hundred thousand and travel wherever you want. So that’s big business and the economy is doing well. People just travel around in their second home. The price-to-sales ratio is 0.6 times, compared with a five-year average of 0.79 times and a 10-year average of 0.81 times.
Q: What else?
A: KB Home (KBH) earns $2.50. They have a price-to-sales ratio of 0.5, compared with 0.55 times for the five-year and 10-year averages. They can raise their dividend. If you look at the catastrophes in Florida, Southern California, Northern California, Texas, and the rebuilding [needed] just to get back to even, KB Home can come in and do a subdivision in a heartbeat.
Sanderson Farms (SAFM) has a price-to-sales ratio of 0.7 times, versus a five-year average of 0.72. They have very high earnings and plenty of room to raise the dividend. They can process 12 million chickens a week. Through good and bad times, people are going to be eating chicken. We prefer the price-to-sales ratio to earnings. It’s a truer number. You can always fudge earnings per share.
Q: What is your view of the market right now?
A: It’s in great shape. When I look at what’s happening with the administration and the midterm elections, I don’t pay attention, because the world leaders are now talking to each other: North Korea is talking to South Korea, Japan is talking to China, China is talking to North Korea. In my opinion, that would be good, long term, for everybody. Business will continue to figure out a way to make money. Tariffs? They will figure out a way around it. They might eat the cost in the short term, but they will get it back into their cost in the long term.
Q: Are we at a top?
A: All the articles say that this is historically the best bull market we’ve ever had. I don’t see that at all. The best bull market that I’ve seen went from August of ’82 through the beginning of 2000, when the market was up each and every year—with the exception of 1990, when it was down one half of 1%. There is no euphoria in the marketplace. Cabdrivers aren’t telling you to buy this or that stock. The last time we had euphoria was everybody talking about real estate in ’06, ’07, and ’08.
If the market takes a little bit of a hit, and then people [believe] we are ready to go into a bear market, they’ll start to sell. But that’s a correction, that’s not a bear market. The main thing for a bear market is you’d have to see inflation get out of control. I chuckle because the kids are whining because the 30-year mortgage rate is 4½%. My first mortgage was 14% or 15%.
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