Although Perpetual’s flows are “worse than expected” for fiscal 2024, Morningstar analyst Sean Lehr believes there are factors that still appear to be working in the asset manager’s favor.

In an ASX filing last week, Perpetual reported its biggest ever quarterly outflows in FY2023-24, totaling $8.9 billion in the three months to June 30.

This followed net outflows of $5.2 billion in the prior quarter, $4.3 billion in Q2 and positive inflows of $0.1 billion in Q1.

In a market note following the update, Lehr noted that the year's significant outflows were likely due to an "uninspiring investment performance" and "noise around the group's strategy".

"Net outflows of about $18.5 billion, 9 percent of funds under management opening, exceeded our forecast of $14.5 billion," he said.

"We expect this to increase pressure on management to reduce costs, secure funds from higher margin client channels and achieve a favorable outcome from the proposed sale of its wealth management and corporate trust assets to KKR."

Earnings headwinds are likely to continue in the medium term, he added, and saw Morningstar cut its fair value estimate for Perpetual to $24.50 a share, down from $26 a share due to larger-than-expected buybacks.

Still, the stock appears "modestly undervalued" at current prices, Lehr said.

Looking at the broader industry, the analyst highlighted that other active wealth managers and platforms saw an improvement in flows towards the end of the fiscal year as potential interest rate cuts boosted investor appetite for equities and other risk assets.

In contrast, Perpetual's worsening net outflows "indicate headwinds to future earnings from Perpetual's poor investment performance and overexposure to less committed institutional clients, which make up about two-thirds of FUM, excluding cash," it said he.

About 80 percent of the estimated $18.5 billion in net outflows came from Pendal brands, he added, although Perpetual said the integration of the Pendal Group was "progressing well."

Still, despite the cynicism surrounding Perpetual's prospects, Lehr maintains there are a few positives working in its favor, such as potential cost reductions.

Fee compression was less than expected, and as suggested in the latest update, there may be further room to cut costs, he said.

"If net outflows continue, we expect management to reduce costs to align with revenues while working to allocate funds through higher margin intermediary channels." Management also noted short-term delays in expected flows in select strategies that should materialize soon if already committed,” Lehr said.

In addition, he expects buybacks to begin to ease as investors' appetite for risk assets continues to improve, "prompting them to continue to invest in Perpetual, and uncertainty over KKR's acquisition of wealth management and corporate trust subsides'.

"We believe the market is currently undervaluing these points," Lehr said.

Looking ahead, it expects underlying net profit after tax at group level to increase "by very low single digits" in the four years to fiscal 2028.

The group's cost/income ratio is likely to remain broadly flat at nearly 80 per cent year-on-year, similar to the first half of fiscal 2024, assuming moderate asset management outflows, slightly lower fee compression and cost reductions.

Lehr also noted potentially solid volume growth in Perpetual's wealth management and corporate trust businesses, both of which face less competition from the asset management business.

“Wealth management and corporate trust continued to increase volumes as expected. However, details of transaction costs, spin-off costs and capital gains tax related to their potential sale to KKR have not been provided,” Lehr said.

The analyst explained that KKR's gross cash compensation of $2.2 billion -- or $19.10 per share -- exceeded Morningstar's combined estimate of $1.5 billion for wealth management and corporate trusts, or $13.30 per share. .

Details of the deal are expected to be discussed further in Perpetual's full-year results at the end of August.

"For the transaction to increase to our fair value estimate, the related expenses and taxes must be less than $630 million," he said.