Part I: Investment opportunities in the global financial sector
On 28 April 2020 we hosted a web-based meeting on the current investment opportunities in the global financial sector. Please click below to listen to our thoughts, including some company specific examples. A summary of the main points is listed below.
The effect of Covid-19 on global financials
Portfolio manager and director
- We believe the market is presenting investors with what Charlie Munger calls ‘The Fat Pitch’ – a baseball term for a ball that is poorly pitched, allowing the batter to strike out confidently and strongly (hitting it out of the park) with very low risk of missing.
- The market fears: (1) a huge bad debt cycle and (2) the risk that banks will need to ask for capital at the bottom of the cycle. In this call we explain why we believe the market is wrong on both counts.
Developed market banking sector
- Capital levels now versus in 2008
- In 2008 banks were involved in a lot of off balance sheet activity which destroyed capital.
- Capital buffers, which have been built up over the years, are available to be accessed if necessary and can then be built up again later.
- Liquidity is at highest levels since the 1980s.
- Bad debt provisions raised in Q1 2020
- Bad debt provisions consist of charge-offs (actual bad debts), which are in line with Q1 2019, and reserve building (not actual bad debts).
- Currently reserve building makes up the large losses for the year, based on companies’ macro assumptions, and these losses will remain volatile in the short term.
- Generally, the banks are being prudent which could lead to reserve build reversals eventually if the market does normalise slightly.
- No matter the provisions raised, the companies remain profitable and profitability should increase after Q2 when most reserves are built up.
- Income statements
- In terms of net interest income, the US is under slightly more pressure due to the Fed cutting rates but also helped by the fact that loan growth has been at all-time highs.
- Fee income very strong in investment banking activities and should remain relatively strong, while consumer banking fee income is under pressure but should bounce back quickly on normalisation.
- There has been a slight reduction in expenses during the current crisis. Generally employees are still employed so there has been no real change in salary expenditure.
Developed market insurance sector and Latin America financial sector
Barry de Kock
- The Denker Global Financial Fund has significant exposure to the insurance sector, with the bulk of the exposure predominately in US non-life businesses. We like these businesses for their defensive characteristics (we tend to favour underwriter-driven companies with modest investment leverage) and management teams who are invested alongside us.
- The insurance sector has been sold down along with the broader financial sector, and we are seeing opportunities to add to current holdings or take positions in companies we have followed for many years.
- We anticipate Covid-19 to have a meaningful impact on the sector, when considering both the assets and the liabilities of insurers.
- We expect some pressure on revenues as GDP contracts, and pressure on net investment income due to lower interest rates.
- Claims are likely to come from more affected lines of business such as travel insurance, trade credit and directors and officers liability insurance. Commentary around retroactively changing contracts to make insurers pay for business interruption claims caused by the pandemic is by far the biggest overhang on the sector at the moment. While certainly a material risk, we feel the probability is low that it materialises and we remain comfortable with our exposure to this line.
- It is likely that the underwriting environment will improve significantly looking ahead as there are many lines of business that will need rates to rise to provide adequate profitability to the businesses writing them.
- In Latin America the fund’s exposure remains fairly modest and we are being more selective. We are invested in businesses with excellent track records of managing credit quality and strong capital ratios. Valuations in certain areas are very attractive and we are taking a measured approach to adding exposure to the region while being cognizant of a number of top-down challenges that exist.
Emerging market financial sector
- We believe Asian emerging markets will remain the drivers of global growth in the coming years. Many of these markets have very favourable demographic characteristics in that they are large, young and growing rapidly.
- Smartphone, banking and mortgage penetration are all extremely low by global standards and we believe the financial sector is directly exposed to the exciting growth opportunities on offer in these countries.
- Many of these Asian emerging market countries are also in very strong fiscal positions with low debt to GDP ratios and the proportion of foreign currency denominated borrowings is low.
- Despite the favourable fundamentals, emerging market currencies and risk assets have been sold off aggressively and outflows have dwarfed those of previous crises.
- In our view, this has led to a dislocation in valuations between emerging markets and the rest of the world. The MSCI Asia EM Financials Index is trading at a 45% discount to its long term average P/NAV multiple whereas the MSCI US Financials Index is trading at only a 20% discount. Based on Shiller CAPE ratios, emerging markets have only ever been cheaper 3% of the time.
- Balance sheets and capital levels have strengthened since the global financial crisis and in sticking to our philosophy of identifying mispriced assets we are excited about a number of quality investment opportunities in the region.
Assessing opportunities in the sector
Portfolio manager and director
- Based on our research and interactions with managements, we believe very few banks will generate losses in 2020 or 2021 and that they’ll continue to grow shareholder value.
- In terms of valuations, the financial sector is currently at a larger discount to the MSCI World Index than ever before – indicating it is at the epicentre of fear.
- The fears of seemingly unquantifiable risks have pushed share prices down to levels that create excellent investment opportunities.
- As certainty and buyers return to the market, they’ll find very few sellers – and prices should react strongly.
- After past crises financials bounced back strongly. See Figure 1 below which shows how the sector and the Denker Global Financial Fund bounced back after the global financial crisis.
- Today the valuations of the investments in the Denker Global Financial Fund are more attractive than they were at the end of the global financial crisis.
Figure 1: Calendar year returns of the Denker Global Financial Fund since 2004.
Source: Morningstar, 31 December 2019. Returns are annual returns and fund returns are net of the A class fees.
From 1999 to April 2004 the fund was managed under a different fund management company but by the same fund manager.
If you have any questions, please contact me at email@example.com
The information in this material belongs to Denker Capital (Pty) Ltd (Denker Capital). This information should only be evaluated for its intended purpose and may not be reproduced, distributed or published without our written consent. While we have undertaken to provide information that is true and not misleading in any way, all information provided by Denker Capital is not guaranteed and is for illustrative purposes only. The information does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment or transaction. Because there are risks involved in buying or selling financial products, please do not rely on any information without appropriate advice from an independent financial adviser. We will not be held responsible for any loss or damages suffered by any person or entity as a result of them relying on, or not acting on, any of the information provided.
This information does not constitute financial advice as contemplated in terms of the South African Financial Advisory and Intermediary Services Act of 2002 (FAIS Act). Use or rely on this information at your own risk. Independent professional financial advice should always be sought before making an investment decision as not all investments are suitable for all investors.
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.
The Sanlam Universal Funds Plc full prospectus, the fund supplement, the minimum disclosure document (MDD) and the KIID are available free of charge from the Manager or at www.sanlam.ie. This is neither an offer to sell, nor a solicitation to buy any securities in any fund managed by us. Any offering is made only pursuant to the relevant offering document, together with the current financial statements of the relevant fund, and the relevant subscription/application forms, all of which must be read in their entirety together with the Sanlam Universal Funds Plc prospectus, the fund supplement the MDD and the KIID. No offer to purchase securities will be made or accepted prior to receipt by the offeree of these documents, and the completion of all appropriate documentation. A schedule of fees and charges and maximum commissions is available on request from the Manager.
Source of performance figures: Morningstar. Returns are annualised and net of fees unless otherwise stated. Annualised returns are returns for a period that are scaled to one year. Collective investment schemes are generally medium- to long-term investments. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments / units / unit trusts may go down as well as up. Changes in exchange rates may have an adverse effect on the value, price or income of a product. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in the portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Actual investment performance of the portfolio and the investor will differ depending on the initial fees applicable, the actual investment date, and the date of reinvestment of income as well as dividend withholding tax. Forward pricing is used. Additional information of the proposed investment, including brochures, application forms and annual or quarterly reports, can be obtained from the Manager, free of charge. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The performance of the portfolio depends on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-div date. The Manager has the right to close any portfolios to new investors to manage them more efficiently in accordance with their mandates. Lump sum investment performances are quoted. The portfolio may invest in other unit trust portfolios which levy their own fees, and may result is a higher fee structure for our portfolio. All the portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No 45 of 2002 (CISCA). The portfolio management of all the portfolios is outsourced to financial services providers authorized in terms of the Financial Advisory and Intermediary Services Act, 2002.