DIY investor

It’s an ill wind that blows nobody any good, so the recent upheavals in the retail investment market had to spell good times for someone. That someone was Hargreaves Lansdown. Middle England’s favourite investment service graduated to the FTSE 100 in March 2011, since when its shares are up another 65 per cent. The company is worth nearly £5bn and its profits are racing ahead.

HL has benefited from two big trends that converged. Thanks to new rules that came in at the end of last year, it is no longer as attractive for financial advisors to serve investors with small portfolios and so many have ditched them to concentrate on wealthier clients. High street banks balked at the cost of training their teams of advisors to the new standards and quit the market, leaving yet more small investors to fend for themselves.

HL’s latest annual results showed very clearly where a lot of these people turned for help. The company’s Vantage service is easily the UK’s biggest online platform for “self-directed” investors, looking after £34.2bn of its clients’ money. So taking a look at how Vantage is doing offers an insight into the service that Britain’s biggest group of DIY investors is receiving. Two things stand out: approval rates of 96 per cent from Vantage customers and stellar levels of profitability. It looks as if everyone’s a winner.

In the year to 30th June, 75,000 people—many of them “orphans,” rejected by their bank or advisor—opened Vantage accounts, lifting the total to 500,000, who between them placed a net £4.8bn with HL during the year. If a third of that new money came from the 75,000 new customers, that would suggest they transferred an average of about £21,000 each to HL—exactly the sort of portfolio most advisors don’t want to know about any more.

Are these Vantage customers getting a good deal? There are some clues in the numbers. Revenues at Vantage rose 22 per cent from £185.7m to £227.2m and the profits on those revenues are huge. HL reports an operating profit margin of nearly 66 per cent—in other words very nearly £150m of that £227.2m flows directly into its coffers.

Vantage’s revenues from all sources represented 0.75 per cent of its clients’ assets, which happens to correspond exactly to the cut that typically goes to the fund manager. But HL isn’t managing its Vantage customers’ money, it’s simply giving them a convenient way to channel it to the fund managers who actually invest it. So the fund manager that makes the key decisions ends up getting paid the same as HL, whose main role is to run an efficient website.

That seems pretty steep to me and it’s not a price that more active DIY investors should feel they need to pay, especially if like me they invest mainly in individual shares rather than managed funds. It’s also a good bit more expensive than a number of very similar alternatives. But it’s a fabulous deal if you’re HL (or a shareholder in them). On several key measures, this is one of the most profitable companies of its size in the country.

Very few large businesses have operating profit margins of 65 per cent (and it’s probably no coincidence that those that do tend to be fund managers). Similarly, I can’t find another business in the FTSE 100 that makes a return on equity of 84 per cent—this is simply extraordinary in a world where anything consistently above 20 is considered excellent.

So HL makes vast profits by doing simple things well and making its service so efficient and user-friendly that investors feel able to put their trust in it—and the bigger it gets, the more people seem inclined to trust it. HL is far from the cheapest service, but it doesn’t need to be. Although the biggest factor in your investment returns is the charges you pay, this is a market in which feeling confident and supported is more important for most people than getting the cheapest deal.

That simple truth has turned Messers Hargreaves and Lansdown into billionaires.