SEI Investments Has Three Highly Profitable Segments; Private Bank Segment Margins Remain Depressed

Equity Analyst

Rajiv Bhatia

SEI Investments consists of four main segments: private banks, investment advisors, institutional investors, and investment managers. A minority interest in value equity manager LSV Asset Management generates about 20% of its pretax income. The firm’s investment advisors, institutional investors, and investment managers segments have been strong drivers of earnings and have strong operating margins, while private banks has been a thorn in SEI’s side, with disappointing revenue growth and operating margins. 

SEI’s private banks business primarily provides investment-processing outsourcing services for banks and trusts. Beginning in 2005, SEI began developing a new feature-rich platform known as Wealth Platform to replace its 30-year-old Trust 3000. It initially focused on the U.K. market then the U.S., mostly on converting Trust 3000 clients to Wealth Platform. SEI has faced some client losses but also some wins, such as Regions Financial and more recently Canadian Imperial Bank of Commerce’s U.S. business. We expect the eventual retirement of SEI’s legacy platform to improve margins over the long term. In addition, as amortization of its platform rolls off, operating margins should improve faster than EBITDA margins. 

The investment advisors segment offers investment management services to registered investment advisors, financial planners, and life insurance agents. SEI has been able to offset lower-fee offerings, such as ETFs, with other products, such as tax-efficient portfolios, but fees have been range-bound. One positive for SEI is that the RIA and broker/dealer channels are generally the faster-growing advisor channels. The institutional investors segment provides outsourcing services for chief investment officers, and we expect it will continue to face strong competition. Though outflows due to pension risk transfers may slow, we expect pressure on the firm's endowment client base. The investment managers segment has performed well, and we expect net inflows in the near term.

Business Strategy & Outlook

Overall, we believe SEI Investments warrants a narrow moat rating. 

One qualitative factor that prevents us from assigning a wide moat rating is that SEI does not have dominant market share in any of its segments. In private banks, we believe Fidelity National Information Services (SunGard) is larger in the relevant markets, and other competitors include Fiserv, Fi-Tek, and Innovest Portfolio Solutions (owned by SS&C Technologies). In the investment advisors segment, Envestnet is far larger, and SEI also faces competition from other turnkey asset-management platforms (such as AssetMark) and RIA custodians. In the institutional investors segment, Russell Investments and Mercer both have greater fully outsourced AUM. In the investment managers segment, the custody banks, SS&C Technologies, and Citco all have a greater amount of alternative assets under administration. Beyond switching costs, which in some segments are quite modest and rely primarily on inertia, we do not see additional moat sources.

We believe SEI’s private banks segment has a narrow moat. SEI notes that over 80% of clients have been with it for more than 10 years and that no client represents 10% or more of segment revenue. Contracts for the firm’s legacy Trust 3000 system are generally three to seven years long, and contracts for Wealth Platform are generally for five to seven years. SEI’s clients run the gamut from large U.S. banks (Wells Fargo, U.S. Bank), regional players (SunTrust, Regions Financial), foreign banks with a U.S. presence (CIBC, BBVA Compass), and smaller community banks. We believe the switching costs stem from client inertia, process disruption, and the length of time to select and implement an alternative system. We believe that smaller banks tend to have higher switching costs. In addition, we believe that implementing a platform-as-a-service model, where in addition to software, SEI performs other investment operations such as custody, securities settlement, and back-office accounting, are stickier than pure software-as-a-service implementations. About 57% of this segment’s investment processing revenue was PaaS. Though relationships can be sticky, client losses can occur from a competitive request for proposal bid or from bank mergers. In addition, the segment's single-digit operating margins have disappointed investors. 

We believe the investment advisors segment is moatier than private banks. Advisors who switch firms face process and client disruption, and we believe the segment’s operating margin speaks for itself. SEI provides a technology platform and provides or (integrates with an outsourced provider) for client reporting, proposal generation, financial planning, customer relationship management, rebalancing, aggregation, tax management, portfolio management, and firm reporting. 

We’d characterize the institutional investors segment as a narrow-moat business. While the operating metrics are strong, qualitatively this RFP-driven business is becoming increasingly competitive. For example, management notes there are more than 85 firms that provide outsourced CIO services. One reason for the increasing competition is that the success of the model has meant that investment consultants (such as Cambridge Associates) have moved toward outsourced CIO offerings. About 40% of this segment’s assets are in defined-benefit plans, and we expect closures/curtailments of these plans to continue to be a headwind, though the defined-contribution market as well as endowments and foundations remain healthy.

In the investment managers segment, contracts for fund administration outsourcing contracts are for three to five years. In addition, it takes a client anywhere from three months to over a year to onboard to a new provider (which can take a year to select). Finally, we also believe the hedge fund part of this business is particularly attractive (we understand about half of the segment’s assets under administration is alternative). Because hedge funds have high fees, they are less sensitive to the basis points paid for fund administration fees. In addition, in some cases, these fees are passed through to investors. Finally, during investor due diligence, switching fund administrators can invite additional scrutiny in a similar way as switching auditors can.

We view LSV, a quant-based value equity asset manager established in 1994 with a seed investment from SEI, as a narrow-moat business because of the concentration of its AUM in value equity products and performance risk. SEI currently has a 38.7% share in LSV and generated $138 million in pretax income from LSV in 2021. SEI’s investment in LSV is $108 million on its balance sheet, suggesting a very high return on invested capital. Given the scalable nature of its quantitative approach, LSV generates 75%-plus operating margins. In 2020, value stocks have meaningfully underperformed the market and LSV has seen elevated outflows.

Narrow

Economic Moat

SEI Investments

SEI Investments Co. engages in the provision of investment processing, investment management and investment operations platforms. It operates through the following business segments: Private Banks, Investment Advisors, Institutional Investors, Investment Managers, and Investments in New Businesses. The Private Banks segment provides outsourced investment processing and investment management platforms to banks and trust institutions, independent wealth advisers and financial advisors worldwide. The Investment Advisors segment offers investment management and investment processing platforms to affluent investors through a network of independent registered investment advisors, financial planners and other investment professionals. The Institutional Investors segment delivers investment management and administrative outsourcing platforms to retirement plan sponsors, healthcare systems and not-for-profit organizations worldwide. The Investment Managers segment gives investment operations outsourcing platforms to fund companies, banking institutions and both traditional and non-traditional investment managers worldwide. The Investments in New Businesses segment focuses on the provision of investment management programs to ultra-high-net-worth families residing in the United States, developing internet-based investment services and advice platforms, entering new markets and conducting other research and development activities. The company was founded by Alfred P. West, Jr. in 1968 and is headquartered in Oaks, PA.

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