Podcast: Is now the time to overweight global financials?

Nigel Barnes

Hello, and welcome to a special edition of the Denker Capital podcast. Today is the 9th of November 2021 and I’m Nigel Barnes. Today I’m joined by Kokkie Kooyman, Barry de Kock and Craig Metherell from the Denker Capital financials team. Good morning gentlemen, thanks for joining me. I’m going to ask one simple question right at the start of this podcast: Is now the time to overweight financials? I’m sure that most people listening have some financials exposure within their portfolios – so this episode should interest everybody.

We’ll focus on three areas for today’s discussion. First question, obviously very topical at the moment, and I’ll aim this at you Kokkie: In terms of the macro picture – inflation and interest rates – there has been lots of discussion and coverage of these topics recently.  What are your thoughts – good or bad for financials?

Kokkie Kooyman

I certainly think it’s a good time to be overweight. Ideally, one would have done it last year (we had quite a few webinars urging clients back then that it was a good time to invest). Looking back at what’s happened in the past 10 years, in fact, even more, we had a downward cycle in inflation as global growth slowed down and interest rates came down into where a lot of the developed market growth interest rates were negative – and that put a lot of pressure on the financial sector. So, the Covid-19 pandemic unleashed quite a few forces: It disrupted supply and it built up demand; stronger growth, which is now actually pushing inflation; and central banks have been dovish, wanting unemployment rates to go lower even and hoping for even more growth. So the bottom line is, those three forces combined could just push world growth for a longer period (or push inflation higher) and that is very good for the financial sector due to higher interest rates – and higher interest rates mean higher volumes at wider margins, and lower bad debts because of stronger growth. So, a very good environment all round for the various segments within the financial sector.

Nigel Barnes

Kokkie, in terms of the segments within the sector, I know you talk a lot about banks – but the financial sector isn’t just banks. Remind us of some of the other areas within the sector?

Kokkie Kooyman

Even within banks, you’ve got the investment banks which have had a very good six months so far with all the new mergers and acquisitions (M&As) and all the initial public offerings (IPOs) – everything that’s happening in fintech is boosting them. Then you’ve got the whole digital revolution (fintech) so there are a lot of new, smaller players coming in, to which we’ve had exposure as well.

In the financial sector you’ve got insurance, where we’ve gradually been increasing our investment, and the debt collection space – a little segment that has been ignored by a large part of the market. The fund has done very well in the debt collection space. This is an unbelievably good environment for debt collectors because, in most of the developed world, the governments have been paying people to stay at home and the guys who were over indebted have been using that cash to first pay off debt. So the debt collectors have really done well – a few names like Arrow Global, Encore, Enova and Kruk are names that most investors will not have heard. If you check out their share prices you’ll see those companies are up around 200%.

Nigel Barnes

Kruk – isn’t that listed in Poland?

Kokkie Kooyman

Yes, Poland. Very good.

Nigel Barnes

Thanks Kokkie. I’ll come back to the fintech example in a moment.

Something that’s very topical at the moment is climate change. Barry, I know you focus a lot on the insurers. Is climate change good or bad for the sector? Could you give us some insight into what’s been happening?

Barry de Kock

Sure. We’ve been increasing our positions in the non-life insurance businesses in the fund recently, based on a positive outlook on what we think will occur with the pricing environment. If you look back at the sector over the last five years or so, the fact is that many companies just haven’t made enough money. A lot of the reinsurance companies in particular have not met their cost of capital over the period, and that’s because we’ve had very elevated levels of natural catastrophes. Since 2017, we’ve had hurricanes Harvey, Irma and Maria and pretty much every year there’s been landfall. There’s also been an elevated degree of what is known as ‘secondary perils’. These include events such as the flooding in Europe and the wildfires in California. Obviously insurance exists to pay claims, but the extent of the claims has been a heavy burden on many of the companies. Coupled with that, lower interest rates over the period, as well as other factors like social inflation in the US which is driving loss costs higher, have hurt earnings. For all of those reasons, we are seeing our companies increase prices significantly. So this is improving underlying margins and also improving top line growth. At the most recent quarter end, a number of our companies have grown their top line from 20% to 50% year on year. So we think there’s a significant opportunity in that space. We’ve also seen a lot of our companies work with clients to not only pay claims, but also to work on loss prevention – helping clients to not end up in a position where they experience loss in the first place. It’s certainly a challenge to the sector but we think, even if we continue to see high levels of activity, that companies are pricing for that and we should see good results going forward.

Kokkie Kooyman

If I can add to that, Nigel – the market punished the insurers, and a lot of the European and other banks, for the low interest rates in terms of the share prices and ratings. So you’re getting your insurers now at record low 10- to 15-year price to NAVs and, as with the banks, the margins are actually improving. So in the next 24 months you should see very good earnings on very low valuations, and that’s really what most investors would like to hear!

Barry de Kock

And it’s even more appealing on a relative basis.

Nigel Barnes

In terms of the insurance sector’s weighting within the Denker Global Financial Fund, Barry?

Barry de Kock

It’s about a quarter of the fund – the bulk of which is non-life insurance with one or two other types of insurance businesses but mainly property and casualty (P&C) type businesses.

Nigel Barnes

So there’s good exposure. Thank you, Barry.

I know that investors looking at the global financial sector are normally really interested in the fintech space. Craig, in terms of fintech, what are the opportunities?

Craig Metherell

To start with a broad view – in terms of how our lives have changed over the last 12 to 18 months, as we’ve lived our lives in our bedrooms, working from home, etc. – the results that we’ve seen from various players that have strong digital capabilities highlight how quickly the conversion from cash to card, for example, has taken place. Digital banks have reported increased monthly active users and daily active users. There’s been a rapid evolution, a multi-year growth story, which has arguably happened within 12 to 18 months in many cases.

The way we like to think about it is that, in the fintech space, you get disruptors, enablers and incumbents. We are finding opportunities in all three of those spaces – many of our existing holdings are rapidly developing their own technological capabilities. JP Morgan, the largest global bank, is very strong on the digital side. However, we think we have some other unique opportunities.

One example is Tinkoff Credit Services, or TCS, the Russian bank that started off as a mono-line credit card provider but is now entirely digitally focused (it has no branches). TCS disrupted the traditional banking space in Russia many years ago, not too many years ago actually – it listed in around 2013 but started in about 2007. They fundamentally changed how people view and think about banking, and not only in Russia but across the world it’s certainly used as a leading example of how to attack incumbents. Whilst it might’ve been regarded as a disruptor back then its, certainly in our view, an incumbent now – an established competitive threat to the large banks and they are looking to expand globally. The fund has been invested in TCS since 2014 or so and it has been a phenomenal performer for the fund. There was a takeout offer by Yandex, an e-commerce player, in September last year at around $27. It’s now trading at $115. So it’s certainly delivered great results for us and we think it sits right in that fintech space. It ties back in with Kokkie’s comments about the diversification of the fund (i.e. banks and insurers), but within banks and within insurers you can argue that fintech is a further category.

Another interesting fintech exposure is a business by the name of VEF (previously Vostok Emerging Finance). This company invests in emerging market fintech businesses right across the spectrum – from a lending business, payments businesses, remittance businesses, ‘buy now, pay later’ (BNPL) exposure, and so on. It’s largely focused on Brazil, given the attractiveness of the economics that the management team, which we rate very highly, find there. There’s exposure to India, Africa, Pakistan, etc. Many of the fintech players that are listed these days are loss-making businesses and we sometimes struggle to wrap our heads around the valuations that they attract. We really trust the approach of the management team of VEF, given our long track record of meeting with them and talking to them. They’re very shareholder minded. It’s a way for us to get exposure to some fast growing emerging fintech assets that are not listed, that we can’t invest in directly. It is growing fast and has certainly been a great investment for us to date.

Kokkie Kooyman

Just to quickly bring VEF to her closer to home… This morning’s Business Day carries a headline of international investors investing in Jumo. Jumo is an African fintech and VEF has a large stake in Jumo. We’ve known Jumo management for a long time, but it’s not listed. So we actually got exposure to Jumo via VEF.

Nigel Barnes

VEF is listed on the Swedish stock exchange right?

Kokkie Kooyman

Yes.

Nigel Barnes

What is the weighting within the fund, Craig?

Craig Metherell

At the moment its small – around half a percent. It’s a small company, in terms of its market cap. So we’re mindful of liquidity constraints, and so on, when investing.

Nigel Barnes

Sure. Since the investments in the fund are only in listed entities, it’s a nice way of investors getting exposure to some unlisted fintech development across the world.

Kokkie Kooyman

A third fintech example, which I’m not sure if Craig was going to mention, is Signature Bank in the US. In its private equity arm it invested in five bitcoin and crypto exchanges and that’s done incredibly well for them. Because we’ve known these guys since about 2009, we were there at the early stages, similarly to TCS. We knew them before the IPO. When Russia invaded Ukraine, TCS’ share price fell below $3 and we loaded it up to, at that stage, 4% of the fund and it went to around 7%. The share price went from $3 to around $120. Unfortunately, in those instances we need to start selling because it just becomes too big a portion of the fund.

Nigel Barnes

Thanks guys. That’s interesting. In terms of the fintech space, we’ve spoken about some of these opportunities and ideas. We’ve spoken of the exposures.  Kokkie, in terms of positioning of the fund right now, could you give us some detail on developed market versus emerging market exposure, or particular sectors? How are you positioned at this point?

Kokkie Kooyman

The US is still the largest portion, about 40%. We’ve been trimming the banks gradually in the US, they’ve actually run fairly hard – so good value but not as attractive as we see in Europe and a lot of our emerging market (EM) exposures. So our EM exposure is about 30%, which includes mostly countries with very good balance sheets like India, Indonesia, Russia, Georgia and Mexico. With the exception of India, these countries all benefit strongly from commodities so they’re doing very well and are poised to do very well for a few years. And then insurance is about 25% of the fund, about 20% of that is in the US and the rest is Europe. Most of the European exposure is in Eastern Europe (much faster growth, better prospects and better valuations). The UK is 7%. The UK is interesting, but we just don’t like the banks enough. One of the recent buys was HSBC, we did buy them about 15 years ago too. The buy was more because of Hong Kong and Asian growth. Hong Kong and China knocked HSBC down and it was already quite cheap, so we slowly started nibbling a bit there.

So the fund is well diversified within the financial space and also geographically.

Nigel Barnes

To finish off, I ask this broader question: Is now the time to overweight financials? The sector and the fund itself have had an extremely good run. Kokkie, can you talk about the performance this year, in dollar terms?

Kokkie Kooyman

Year to date (YTD), I think the fund has returned 35% in dollars. On a 12-month basis I think it’s 80%. [See the note below for the exact returns of the Denker Global Financial Fund’s A class as at 31 October 2021.*] But, very importantly, the PE of the fund is about 7.4, versus the MSCI World’s PE of 22. So the MSCI World is a big concentration of very expensive shares like Facebook, Tesla and Apple. Then you’ve got the financial sector that is quite cheap relative to the MSCI World. Remember, as Barry alluded to, with interest rates going up, that relative gap is going to close because the higher interest rates are going to bring your expense of growth stocks down and actually favour financials. In terms of earnings growth, and this comes from FactSet and not our own forecasts (although our forecasts corroborate that), the earnings growth for the next two years is going to be between 20% and 30% in the financial sectors. You have a very mispriced financial sector and very strong earnings growth, aided by high interest rates.

Nigel Barnes

What is your expectation for the next 12 to 18 months in terms of dollar performance?

Kokkie Kooyman

We’ll give a fairly conservative number. We believe it’s somewhere between 12 and 15% per annum for the next two years. How I get that is by looking at the average return on capital, in other words shareholder value growth of the sector, which is about 15%. So they’re returning 15%, and a third of that (even more, in some cases) you’re getting back in dividends or you’re getting it back in share buybacks. If you think of the PE of 7.4, the sector is still cheap. So you should get 15% plus rerating. So 15% I think is quite conservative versus a market that is very expensive and most commentators expecting the market to correct. We think it will be a rotation from growth into value and cyclical, as we’ve already been seeing. It’s been happening for a year, slowly. We’re surprised at how many investors we see who have missed very heavy growth by being underexposed to financials. We think the fund gives investors a great opportunity to close that gap – to go overweight financials in the next 12 months.

Nigel Barnes

Any exposure to South Africa in the fund?

Kokkie Kooyman

Zero.

Nigel Barnes

I think that’s an important point in terms of diversification for a South African investor who might have a reasonable portion of assets invested locally but have maybe moved some money overseas. This is a nice diversifier – the fund is Dublin domiciled, it’s available on all the main platforms and its easily accessible.

Gentlemen, thank you. I think we’ll leave it there. I think that’s been a really good short update on the opportunities that exist within the sector and the way that the fund is positioned. Kokkie, thank you for giving us some idea as to what you expect from a performance point of view over the course of the next year or two.

Thanks guys.

*The Denker Global Financial Fund’s A class returned 30.8% YTD and 72.2% for 12 months, as at the end of October 2021 in US dollars (net of the A class fees of 1.25%).

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