Financial review and key performance indicators

GROUP UNDERLYING PROFIT INCREASES 37%

Key performance indicators

Our KPIs are identified by the symbol and commentary on our progress is provided in the accompanying text. Our KPIs are:

1. investment performance;
2. fee margins;
3. fund flows excluding Pearl;
4. operating margin and compensation ratio;
5. earnings per share (EPS); and
6. treating customers fairly (see page 20).

Key financial highlights

• 70% of funds achieving or beating benchmark over one year
• Underlying profit increased 37%
• Total fee margin improved to 61.7bps
• Net higher margin inflows of £2.0bn
• Operating margin improved to 30%
• Compensation ratio stable at 44%
• Basic EPS on underlying profit increased 36% to 10.2p

Investment performance

The investment performance of the Group’s funds is good with 77% and 63% of Equity and 62% and 82% of Fixed Income funds achieving or beating their benchmarks over one and three years respectively. UK Retail performance was good with 70% of assets outperforming over one year. In our UK Retail fund range, performance was adversely impacted by legacy New Star funds and only 41% of assets outperformed over three years; however, excluding New Star funds, 65% of assets outperformed.

Horizon performance improved significantly in the year with 83% and 88% of assets outperforming over one and three years respectively. This has driven record flows into these funds. Performance of the US Retail fund range has been disappointing with 11% and 16% of assets outperforming over one and three years respectively. This is due to the Henderson International Opportunities Fund, representing approximately 65% of US Retail assets, underperforming.

In the Institutional business, all fund classes continued to perform well over one and three years, with 100% of enhanced index funds outperforming over one year and 92% over three years. In our Institutional Fixed Income funds, 64% outperformed over one year and 97% over three years. Hedge fund performance suffered over the one year period, with 67% outperformance; however, three year performance remains good with 81% of funds outperforming. Of our funds 91% are above or within 5% of their high watermarks.

In Property, the one and three year performance track record is pending publication of the IPD Annual Benchmarks in March 2011. However, estimates derived from the monthly data show that the one year performance numbers should improve significantly with circa 65% of funds achieving benchmarks or better in 2010. Encouragingly, investor confidence in the long-term performance of the Group’s Property business has remained strong.

New Star Investment Management (NSIM) performance has improved significantly during the period with 98% of assets outperforming over one year. However, the three year investment performance is disappointing with 55% of assets outperforming.

The number of buy rated products increased by 12 to 135 during the period. In addition, the Group won a number of investment performance awards including:

• FT Business Pension and Investment Provider Award – UK Fixed Income Manager of the Year;
• Investment Week Fund Manager of the Year – Multi Manager Group of the Year; and
• Lipper Best European region fund over five years: US.

KPI

Fixed Income and Equity funds continued to perform well with 62% and 77% respectively of assets achieving or beating their benchmarks over one year and 82% and 63% respectively over three years.

Investment performance over 1 and 3 years

The Group financial result

Underlying profit before tax in FY10 was £100.7m, an increase of 37% on FY09 (£73.7m). Profit before tax was £76.5m, compared to £15.5m in FY09.

Revenue and fee margins

Total fee income increased by 28% to £362.1m from £283.3m in FY09. Management fee income increased by 25% to £282.5m from £226.8m in FY09, due to a full year of revenues from New Star assets (acquired in April 2009), the impact of higher margin net inflows and higher market levels. The FTSE 100 Index was on average 20% higher in FY10 compared to FY09.

Transaction fees increased by 48% to £36.8m from £24.9m in FY09, primarily due to fees earned on UK Wholesale funds (including New Star) and transactions related to our Property business. Performance fees increased by 35% to £42.8m from £31.6m in FY09, primarily due to fees earned from institutional mandates. The main contributors to performance fees are illustrated below.

Sources of performance fees (%)

Total fee margin increased from 53.5bps in FY09 to 61.7bps in FY10, largely due to higher transaction and performance fees and improving management fee margins following the New Star acquisition and higher margin net inflows. Average management fee and net margins in FY10 were 48.2bps (FY09: 42.8bps) and 17.2bps (FY09: 13.9bps) respectively. Over the past 24 months, the Group’s strategy of growing higher margin assets, which now represent 59% of total AUM (FY09: 56%, FY08: 48%), has helped increase the management fee margin by 13% in FY10.

KPI

Total fee margin increased in FY10 due to higher transaction and performance fees together with a full year of revenue from New Star. Improving management fee margin illustrates the shift from lower to higher margin business. Net margins have improved as underlying profits grew in better market conditions.

Fee margin (bps)

Finance income

Finance income in FY10 decreased by £3.5m to £0.8m, primarily due to lower cash balances, lower interest rates and the impairment of a seed capital investment in a property fund.

Operating costs

Operating costs increased by £48.5m to £253.5m in FY10. The main components are shown in the table below:

	FY10 Audited £m	FY09 Audited £m
Employee compensation and benefits	161.1	126.3
Investment administration	23.3	22.6
Information technology	12.7	11.5
Office expenses	16.2	16.2
Depreciation	3.2	3.2
Other expenses	37.0	25.2
Operating costs	253.5	205.0

Employee compensation and benefits increased £34.8m to £161.1m (FY09: £126.3m). Within this, fixed staff costs increased by £6.3m, reflecting the impact of New Star for a full year and salary inflation, whilst variable staff costs increased by £28.5m, driven by improved Group profitability. The average number of full-time employees remained stable in FY10 at 938 (FY09: 933). The compensation ratio also remained stable at 44.4% (FY09: 43.9%) as shown in the graph on the following page, mainly as a result of higher variable staff costs. The Group continues to manage its cost base in line with its income to protect the Group from any significant market dislocation.

Investment administration costs increased by £0.7m to £23.3m, primarily due to the increased number of funds following the New Star acquisition. Information technology costs increased by £1.2m to £12.7m due to the write-off of capitalised software costs, the New Star acquisition and inflation.

Other expenses increased by £11.8m to £37.0m, of which £3.0m represents costs incurred in relation to the potential acquisition of RidgeWorth on which the Group terminated discussions in June 2010. In addition, the Group has continued to invest in targeted strategic business development, in particular, relating to the UK Retail business, through marketing, events and promotions, with an impact of £6.2m. The Group has also seen an increase in irrecoverable VAT of £4.0m, partly offset by net foreign exchange gains in FY10 of £1.6m (FY09: £0.3m loss).

KPI

The operating margin improved in FY10 to 30.0% (FY09: 27.6%) due to the increase in market levels, a full year of revenue from New Star funds, higher performance and transaction fees and the Group’s continued cost control. The compensation ratio remained stable at 44.4% (FY09: 43.9%), in line with remuneration policies linked to  improved Group profitability.

Operating margin and compensation ratio

Finance costs

Finance costs in FY10 were £8.7m, £0.2m lower than FY09, and continue to include the amortisation of the profit arising from an interest rate swap on debt in December 2008. The unamortised profit on the interest rate swap as at 31 December 2010 stood at £4.1m and will be amortised over the residual term of the debt, which matures on 2 May 2012.

Non-recurring items

There were four non-recurring items in FY10 resulting in a net pre-tax charge of £10.5m (FY09: £47.5m charge), but a post-tax credit of £6.5m (FY09: £35.2m charge) as shown opposite:

	FY10 Audited £m	FY09 Audited £m
FSCS interim levy	(7.6)	–
Goodwill impairment	(8.7)	–
Towry Law International provision release	5.8	–
Impairment of seed capital investments in three property funds	–	(7.3)
Infrastructure fund management fees	–	(20.7)
Insurance recoveries	–	14.3
New Star integration costs	–	(33.8)
Non-recurring items before tax	(10.5)	(47.5)
Tax on non-recurring items1	0.6	12.3
Non-recurring tax	16.4	–
Non-recurring items after tax	6.5	(35.2)

Note

1. The goodwill impairment is disallowable for tax purposes.

FSCS interim levy

In November 2010, the FSCS indicated that it would raise an interim levy on investment managers in respect of claims received primarily from investors in Keydata Investment Services Limited (in administration). The Group has provided for this levy in full during 2010.

Goodwill impairment

The goodwill allocated to the NSIM cash generating unit, (a specialised segregated company, formerly part of New Star), as a result of an earn out deal in respect of that company, has been impaired in full as a result of a 50% decline in AUM.

Towry Law International provision release

During the second half of 2010, the majority of a previously recognised product mis-selling provision, relating to legacy Towry Law International products, was deemed no longer required and was released. This resulted in a £5.8m credit in 2010.

Non-recurring tax

During the second half of 2010, HMRC closed enquiries into certain prior year tax filings, resulting in the Group releasing tax provisions of £16.4m.

Tax

The tax charge on recurring profit for the period was £16.1m, giving an effective tax rate of 18.5% (FY09: £13.3m, 21.2%). The effective tax rate on recurring profit is less than the UK corporation tax statutory rate of 28%, primarily as a result of the net favourable effect of different statutory tax rates applying to profits generated by non-UK subsidiaries. In addition, deferred tax balances have been adjusted for the 1% decrease in the UK corporation tax rate effective from 1 April 2011.

AUM and fund flows

Total AUM at 31 December 2010 were £61.6bn, 6% higher than at 31 December 2009 (£58.1bn). The Group generated higher margin net inflows of £2.0bn and net inflows of £0.4bn in Institutional. These net inflows were offset by lower margin outflows from Cash funds (£1.0bn), NSIM (£1.0bn) and Pearl (£1.8bn) and the transfer of the Henderson International Property Fund to Aviva Investors (£0.2bn). Outflows from Pearl will have no material impact on expected future revenues due to the fee compensation arrangements in place with this client.

AUM by asset class (%)

The chart above shows AUM by asset class and includes cash holdings within products in Fixed Income AUM and fund of fund holdings in Equities AUM. Property asset class AUM excludes £0.4bn of cash holdings (2009: £0.3bn) and £0.6bn of fund of fund holdings (2009: £0.6bn) held in Property-related products. The increase in Equities AUM is due to net inflows into Horizon funds and the increase in equity market levels. Fixed Income AUM has fallen mainly due to outflows from Cash funds and Pearl. The increase in Property funds is mainly due to inflows during the year.

Summary of movements in AUM

	Opening AUM £bn	Net flows FY10 £bn	Fund transfer1 FY10 £bn	Market/FX FY10 £bn	Closing AUM £bn	Management fees2 FY10 £m	Management fees2 FY09 £m
Higher margin
Investment Trusts	3.5	(0.3)	–	0.5	3.7	14.9	12.9
Horizon funds	3.4	1.0	–	0.7	5.1	39.1	24.2
UK Retail	10.3	0.3	(0.2)	0.2	10.6	79.2	59.8
US Retail	3.2	–	–	0.4	3.6	28.5	21.3
Hedge funds	0.9	0.1	–	0.1	1.1	13.1	10.4
Property (non-US)3	7.6	1.3	–	0.3	9.2	37.4	32.1
Property (US)	1.3	–	–	0.1	1.4	5.3	5.5
Private Equity4	0.6	–	–	0.1	0.7	5.5	9.5
Structured Products	1.8	(0.4)	–	(0.2)	1.2	6.3	4.4
Higher margin total	32.6	2.0	(0.2)	2.2	36.6	229.3	180.1
Lower margin and Pearl5
Institutional clients	13.2	0.4	–	1.8	15.4	/	/
Cash funds	2.3	(1.0)	–	–	1.3	/	/
NSIM	2.0	(1.0)	–	0.1	1.1	/	/
Lower margin total	17.5	(1.6)	–	1.9	17.8	/	/
Pearl	8.0	(1.8)	–	1.0	7.2	/	/
Lower margin and Pearl total	25.5	(3.4)	–	2.9	25.0	53.2	46.7
Total	58.1	(1.4)	(0.2)	5.1	61.6	282.5	226.8

Notes

1. Transfer of the Henderson International Property Fund, acquired as part of New Star, to Aviva Investors.
2. Net of commission expense.
3. Property AUM at 31 December 2010 excludes £0.8bn of UK Retail funds and £0.4bn of Pearl Property managed funds.
4. Private Equity AUM (based on 30 September 2010 valuations) excludes £0.1bn of Pearl Private Equity managed funds.
5. The composition of lower margin and Pearl management fees by category is not shown due to client confidentiality.

KPI

Horizon and UK Retail funds had net inflows of £1.3bn in FY10. Property net inflows of £1.3bn in FY10 included the purchase of a 50% stake in Westfield Stratford City on behalf of clients. Net inflows into Institutional were more than offset by outflows from lower margin Cash funds and NSIM in FY10.

Net fund flows excluding Pearl (£bn)

KPI

EPS on underlying profit increased in FY10 as a result of the Group generating higher earnings due to improved market conditions and continued cost control.

Earnings per share (p)

Pension schemes

The Group has three types of pension schemes. A defined benefit scheme and a defined contribution scheme, together forming the Henderson Group Pension Scheme (Pension Scheme), and three smaller unapproved pension top-up schemes for previous executives.

There was a net surplus in the Pension Scheme of £112.5m at 31 December 2010 (2009: £90.0m). The increase in the Pension Scheme surplus during 2010 is due to better than expected returns on the asset portfolio and a lower assumption for future price inflation, based on the Bank of England’s published price inflation curve, set at 3.6% per annum (2009: 3.7% per annum). These increases were partially offset by a lower discount rate used to value the Pension Scheme’s liabilities for accounting purposes, set by reference to AA-rated corporate bonds with approximately 20 years’ duration, down to 5.4% per annum from 5.6% per annum in 2009.

The liability in respect of the Group’s unapproved pension schemes amounted to £6.2m at 31 December 2010 (2009: £6.1m).

Regulatory requirements

The Group is subject to regulatory oversight and inspection by the FSA and other international regulatory bodies. Consequently, the Group’s internal controls, governance, procedures and capital are reviewed on a continuous basis. Both management and the Board of Directors ensure that the Group is compliant with its regulatory obligations at all times. The Group has a waiver from consolidated supervision in place, valid until April 2014. The regulatory capital surplus of the Group under the Parent Financial Holding Company test amounted to £304m at 31 December 2010 (2009: £323m).

Dividends

The Board is recommending a final dividend for 2010 of 4.65 pence per share, which will bring the total dividend for 2010 to 6.5 pence per share, an increase of 0.4 pence per share from 2009. The proposed final dividend will be paid on 27 May 2011 to shareholders on the register on 6 May 2011.

The Board has adopted a progressive dividend policy and will continue to apply a dividend formula where the interim dividend will be 30% of the total dividend of the previous year, assuming the Group has the resources to fund the dividend.

Gartmore Acquisition

On 12 January 2011, the Group announced that it had reached agreement with the board of Gartmore on the terms of a recommended acquisition by the Group of the entire issued share capital of Gartmore (Gartmore Acquisition). The acquisition will reinforce the Group’s position as a diversified fund manager with product strength in traditional long-only and absolute return offerings and will significantly enhance the Group’s presence in UK retail asset management. Subject to regulatory and shareholder approvals, the acquisition is expected to complete on 4 April 2011 with integration expected to be completed during 2011.