The most recent performance ranking from Morningstar shows that the Sanlam Global Financial Fund has delivered stellar returns for the 12 months ending June 2017. But what can we expect from global financials going forward? Fund manager Kokkie Kooyman says that the current market environment is indicating that we are only at the beginning of a global financials bull run that could last several years.
A lot has changed over the past 12 months in terms of sentiment towards financials
By June 2016, Russia had invaded Ukraine, the oil price had fallen from $110 to a multi-year low of $25 (US dollars per barrel), and US banks had been sold down on fears of large oil industry exposures. These events raised concerns among investors and steered them away from financial shares. A year later however, the Sanlam Global Financial Fund’s A class has gained 42.6% versus the 18.2% return from the MSCI World Index. The question is: does this point towards a missed opportunity (up until now) and an indication of what investors can expect going forward?
I believe the financials bull run has just started
I have managed funds during two bull cycles: between 1989 and 1997, and between 2002 and 2007 when we had the global equity and financials bull market. Based on these experiences I believe we are in fact at the beginning of a global financials bull run, rather than at the end of a bull run, for the following reasons:
- Financial activity should increase going forward
– There are indications that the global low-growth, low-inflation, low-interest-rate environment has finally come to an end.
– This is good for confidence, since it will trigger increased financial activity in the form of investment, lending and mergers and acquisitions.
- The rise in financials is starting from a low base, leaving room for long-term growth
– The upswing has started from a very healthy and low base and the financial sector generally has strong and clean balance sheets (with a few exceptions in Greece, Italy and Spain).
– Because it starts from such a low base, the wave should last several years. This should result in higher net interest margins and improved cost-to-income ratios, which should in turn lead to a period of sustained, above-average shareholder value growth.
- Fewer regulatory challenges mean lower costs
– The regulatory headwinds seem to have peaked. Going forward, the automation of the additional information requirements will result in cost savings by banks and insurers.
- Higher interest rates should enable banks and insurers to re-rate
– Finally, the financial sector remains undervalued and higher interest rates should see both insurers and banks re-rate and outperform the general equity indices.
In short, I believe the driving forces behind the rally could continue for anything from four to 10 years, which may support financials’ outperformance of other sectors over that period.
Our fund is well-positioned to benefit from future growth and mispricings
Over the past 17 years, our investment philosophy, process and experience have led us to select many mid and smaller market cap winners that enabled the Sanlam Global Financial Fund to outperform its benchmark (the MSCI World Financials Index) consistently by quite a considerable margin (as shown in Figure 1). In addition, Figure 2 shows that – according to latest Morningstar rankings – the fund has outperformed its peers since inception, maintaining first position among 30 global funds over a period of almost 15 years. The environment we’re heading into will be conducive for medium-sized companies that a) grow faster than the large index companies and b) are often mispriced.
However, it is also vital to understand that the Sanlam Global Financial Fund focuses on investing in financial companies that have a track record of growing shareholder value and that are under-priced at the point when we invest. Based on their past five-year track records (in a tough environment) the projected growth in shareholder value for the average investment in the fund should be more than 12% per year. In addition, we feel that the shares are mispriced, leaving room for further growth in value.
Figure 1: Sanlam Global Financial Fund – 17-year record of outperforming its benchmark (cumulative returns as at 30 June 2017)
Source: Denker Capital, Morningstar
Figure 2: Performance of the Sanlam Global Financial Fund (as at 30 June 2017)
Source(s): Denker Capital, Morningstar
Note: The relatively lower 3- and 10-year returns can be attributed to short periods of low returns due to a struggling economy (in 2015/2016) and a recession (in 2008/2009).
The power of compounding for patient, level-headed investors
Few people realise the effect of compounding, so an example may help to highlight this. If you had invested $100 in the Sanlam Global Financial Fund in 2000 you would now (end of June) have $864; if you had invested the same amount in the MSCI World Index, it would now be worth $231, only a quarter of the value of the fund investment.
Even if you invested almost at the top of the financial bull market in June 2007, the fund would still have made up for the initial loss in 2008, compounding at 3.1% over the next 10 years (versus the MSCI World Financials Index return of -0.7%, as shown in Figure 2). This places the Sanlam Global Financial Fund third in its global category and in the top quartile of all South African funds (across asset classes) over that period. In fact, the more recent quarter-end performance figures from Morningstar for the past year show that the fund was the top-performing fund out of all funds in South Africa available to the public for investment, across all fund categories.
Figure 1 highlights the short-term influence of many factors on the sector. The events in 2008 affected the financial sector much more than it did the general market. Similarly, the oil price collapse to $25 per barrel in February 2016 affected the financial sector’s performance. However, after each shock the shares recovered, proving their long-term attractiveness based on their underlying ability to grow shareholder value.
The next few years could be a golden period for financials
We don’t think we’re in an environment that reflects either June 2007 or January 2009. However, based on our experience of the past 30 years, we think the probability is high that the next few years could be a golden period for financials.
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