The current market panic has dealt a significant blow to the financial sector, presenting very attractive investment opportunities. In fact, in my 30 years of researching and analysing banks and insurers, I have never seen opportunities like this. In this article we put aside the emotions fuelled by the negative media coverage, look at some of the facts and compare the current situation to the global financial crisis of 2008/2009. It’s important to remember that, irrespective of how bad the situation looks, markets tend to overreact to the current scenario before looking forward. You can’t control what the markets will do – but the decisions you make today are likely to have an impact on your investment returns for years to come.
The financial sector has declined significantly, presenting very attractive investment opportunities.
Last week, European financials were trading at new lows following the 1987 Black Monday lows, recording a decline of 28% in just two weeks. Figure 1 shows that this has been the sharpest correction compared to other periods of decline in the last century.
Figure 1: Trajectory of historical 25% drawdowns of US large cap stocks from 1 July 1926 to 13 March 2020 (scaled to start on 20 February 2020)
Source: Ken French, Bloomberg, Analysis by ReSolve Asset Management
At close of business on Monday (16 March), the MSCI World Financials Index was down 37% (in US dollar terms) from its 17 February 2020 peak. The decline has pushed quality banks and insurers throughout the world to record low prices, with stocks like ING Group in the Netherlands now on a forecasted dividend yield of 9%.
With markets around the world in turmoil, the financial sector should be the one that bounces back the most.
It is difficult to be positive amidst the current doom and gloom but once the turmoil caused by Covid-19 settles down, the financial sector should remain well positioned to grow shareholder value at 14%+ per annum. Figure 2 illustrates the impact different returns would have on shareholder value over the long term.
Figure 2: The value of $100 invested today in 10 years’ time
Source: Denker Capital
If our assumptions and the results of our research are correct, in 10 years’ time those who invest now will look back and be glad that they were brave enough to take advantage of opportunities at a time when so many others were fearful.
Comparing 2008 to 2020 – the financial sector has learnt from past mistakes.
Let’s go back to the global financial crisis. In 2008, markets were down over 50% in US dollar terms, but showed significant gains the next year as shown in Figure 3 (the MSCI Emerging Markets Index gained 79.0% and the MSCI World Financials Index 31.1%).
Figure 3: Returns of the Denker Global Financial Fund and MSCI indices during and after the global financial crisis
Source: Morningstar, Denker Capital (31 December 2019)
There are several differences between the two sell-offs that are very important to understand in the context of the financial sector, which explains our confidence that there will be a sharp rebound.
Figure 4: Differences between the 2008 global financial crisis and the 2020 Covid-19 pandemic
Source: Denker Capital
The companies in which the Denker Global Financial Fund invests have been chosen for their quality and proven ability to grow shareholder value in both good and bad times.
Our experience has shown that events like these shake out poor management teams (who were, for example, over-geared), and provide good management teams with strong balance sheets with the opportunity to take market share or buy weak opponents. In Figure 5 we show how JP Morgan and Essent Group have continued to grow shareholder value throughout the turbulence of the past 15 years, including 2008/2009. Based on these figures, and our research and contact with their management teams, we believe we can safely assume that this will also be the case in 2020 and thereafter. Yet, despite this track record, the market has sold them down to their lowest valuations (as measured by their price to book or P/B ratios) in 20+ years.
Figure 5: The valuations of our two largest holdings indicate it’s time to invest.
Source: Denker Capital. The book value per share includes accumulated dividends per share.
The diversification of our fund holdings across approximately 50 companies in the financial industry (retail banks, commercial banks, insurers, debt collectors, etc.) across the US, Europe, the UK and about 10 emerging markets, reduces risks significantly. With our long history of managing the fund, the quality of the companies we are invested in is high, as is evident in Figure 6 below.
Figure 6: Even measured from the February 2020 low point, the Denker Global Financial Fund has outperformed over most periods.
Source: Morningstar, Denker Capital (29 February 2020)
Inception date: October 2004. Annualised return is the weighted average compound growth rate over the period measured. Cumulative return is the aggregate return of the portfolio for a specified period. The highest annual return in the last 10 years was 30.3% and the lowest was -17.2%. These are based on a calendar year period over 10 years.
We’ve made some changes to the portfolio and are proactively monitoring the environment for opportunities.
• At the initial outbreak of the virus we had very little by way of investment in China (and nothing in Italy). The small indirect investment we did have in China (Prudential) was reduced.
• Fearful market reactions have pushed the valuations of several of our portfolio holdings down significantly − well below levels that we believe reflect the reality of the coming years. We have used this opportunity to add to our positions with the strongest balance sheets.
• We increased the quality of the portfolio further by increasing our investment in the property and casualty insurance sector. This sector could benefit from the increased demand for pandemic cover and event cancellations.
• The fund has held up well but, as can be expected, has taken a knock in the last week as the market started selling smaller cap, higher growth financials. These should bounce right back as the shutdowns are reversed.
• The fund’s current cash position is at a minimum (well below historical levels), reflecting the level of attractive valuations and long-term upside we see.
No one knows when or how the current market meltdown will end, or how to call the bottom.
Successful investors don’t try to call the bottom. Rather they invest when there is a disconnect between intrinsic value and price. At the moment, some of them are likely to be once-in-a-decade opportunities that will generate good returns in the years to come.
Investors can invest in the Denker Global Financial Fund in US dollars, British pounds or euros. Please contact us at investorrelations@denkercapital.com for more information.
To view the latest fund fact sheet (or minimum disclosure document), please click here.
‘In the short-term Mr Market will quote wildly diverging prices depending on whether he wakes up in a manic phase or a depressive phase each morning. This makes the market very inefficient in the short-term.
However, we know that over the long term the market is efficient and will reflect the true value of good businesses. Therein lies the opportunity for the intelligent investor. ‘
Benjamin Graham, The Intelligent Investor
Kokkie Kooyman
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The Denker Global Equity Fund, Denker Global Dividend Fund and Denker Global Financial Fund are sub-funds of Sanlam Universal Funds Plc, a company incorporated with limited liability as an open-ended umbrella investment company with variable capital and segregated liability between sub-funds under the laws of Ireland and authorised by the Central Bank. The Manager of these funds is Sanlam Asset Management (Ireland) Limited (Beech House, Beech Hill Road, Dublin 4, Ireland, Tel + 353 1 205 3510, Fax + 353 1 205 3521) which is authorised by the Central Bank of Ireland, as a UCITS Management Company, and an Alternative Investment Fund Manager, and licensed as a Financial Service Provider in terms of Section 8 of the FAIS Act. Sanlam Collective Investments (RF) (Pty) Ltd is the South African Representative Office for these funds.
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