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10176
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3978
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Investment Trust Masterclass - Financials: opportunities in a broad sector with Simon Gergel, Manager of the Merchants Trust, Allianz Global Investors; Garrett Fish, Manager of the JP Morgan America Investment Trust and John Husselbee, CEO of North Investment Partners.
Bookmarks:
0|Opportunities
33|Banks to big to fail or succeed?
138|Operations of a large companies
246|How aware are fund mangers?
294|The cost of regulatory business
432|Time spent looking at your portfolio
550|A fan of insurance companies?
773|Non bank investment exposure
899|Dents in profits?
978|Property investment is now the time?
1024|Sub sectors where to invest?
Duration:
00:21:05
Recorded Date:
11 September 2013
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Transcript:
PRESENTER: Financials make up something like 20% of the world’s developed stock markets, but there’s a huge amount of variety within that. To discuss the opportunities and the threats I’m joined here by an expert panel, let’s meet them. They are: Simon Gergel, Manager of the Merchants Trust; Garrett Fish, Manager of the JPMorgan America Investment Trust; and John Husselbee, CEO of North Investment Partners.
Garrett Fish, looking at retail investment banking, which many people is synonymous with financials, these big investment banks, are these institutions too big to fail or too big to succeed?
GARRETT FISH: Well, I think from a standpoint, from the straight investment banking, and regarding regulation, regulation is more directed towards them solely from a leveraged standpoint. That’s where the leverage was built up within the system. From an investment banking standpoint, we have some standalone companies, but also are built within kind of larger financial enterprises. I don’t think from a too big to fail that’s a really difficult question, because even if you compare, you know, within the US we have deposit limits of 10% caps across the scale, several companies are near or at that level right now, but if you compare, and this is kind of getting outside of my investment universe, but if you simply compare Canada to the UK.
UK, I believe, and hopefully I’ll be corrected if I’m wrong, it’s had call it five to ten banks, whereas things did not turn out so well in the financial crisis. Canada on the other hand has five to six banks, they went through, and it’s just a function of how much risk they take on the balance sheet, where they take those risks and Canada as I said came through very well, UK did not, and many US banks, you know, we basically had a mix. We had some very very poor and we had some very, very strong. From where we stand now, I don’t think we’re getting back to that standpoint. I think from an investment bank standpoint, their business models are changing significantly, their leverage is coming right down, they’re getting back to almost old line investment banking regarding mergers and acquisition, more from an advice standpoint, and their trading operations, as well as the big banks, that’s the side that’s shrinking.
PRESENTER: Okay, and Simon Gergel, when you see a bank like HSBC, which you’ve got a holding in at Merchants Trust, is it an organisation that a management can run and operate efficiently or is it just too big?
SIMON GERGEL: I think they can. I think one of the advantages they’ve got of being globally spread and having regulatory capital and a regulated structure in every country is that they can allocate capital to where they see good returns. I mean one of the problems is if you’re purely a domestic bank, if the UK economy’s not offering good opportunities to invest your cash, you can get limited growth. You can give it back to your shareholders, but you can’t grow particularly fast. If you’re HSBC operating in lots of countries around the world, there’s usually somewhere where you can allocate capital and get a good return.
In banking the worst thing to do is allocate capital into an area where the returns aren’t attractive, where the margins are too narrow. So HSBC has the great benefit of being widespread both for raising deposits but also for finding opportunities to commit their capital. I think they are good at managing their business. I mean clearly it’s difficult to manage a big integrated multinational group, but I think they’re relatively good at it.
PRESENTER: But economic growth in the West is pretty sluggish, and it’s slowing in Asia, if you’re a bank like HSBC, where’s the most efficient place to put your capital?
SIMON GERGEL: Well, I mean until the financial crisis it clearly was areas like Asia, but I think in the last two or three years, you know, if you’ve been able to allocate money to the UK mortgage market, for example, it’s been quite profitable. The Government’s got this help to buy scheme now, which is boosting housing transactions. It’s very profitable for the banks if they can lend money to the UK housing and have the Government guarantee effectively the first 20% of the loan, from 5 to 25%, and you just have the risk below that. So there are pockets of value, pockets of good opportunities to allocate capital in the developed world as well as the emerging markets.
PRESENTER: And John Husselbee, when you’re talking to fund managers, how confident are you that they sort of know that there’s full transparency in some of these big organisations, there’s not going to be a fine, somebody opens a drawer and goes my goodness that’s a problem we’ve got to get round to sorting out now, how confident can you be on that today?
JOHN HUSSELBEE: Well, just as confident as if we’ve ever been I think. I don’t think much has changed in that respect. Yes clearly we’re living in a world of further transparency, and tighter regulation I suppose is the confidence there, but I think it’s just been the same old same old. It’s an issue that we all face day-in day-out. So yes I don’t think that the transparency, clearly it’s not the blame for everything, but clearly that’s where investors, the general public want to put it.
PRESENTER: Garrett, I mean these regulatory and sort of capital burden headwinds, if you like, are they just the cost of doing business if you’re a big financial institution or can they be crippling?
GARRETT FISH: I don’t believe, well, from what we understand where they’re going, crippling, no, but from a standpoint of they are increasing. Even from, if we take a step back and we look at kind of returns in growth, that’s why financials generally don’t have a very high P/E ratio or even from a price to book ratio relative to the rest of the market, especially at least from our standpoint, from a trading standpoint that’s why you put a very low multiple on trading, you don’t know when there could be the next big surprise. Whether it be, especially in a global enterprise, or it doesn’t even have to be a global enterprise, you don’t know where the leverage is, you don’t know whether the market’s gone to the other side of that trade, that’s why the multiples have always been low in those markets.
The other risk is just from a corporation allocation standpoint companies allocate money to the fastest growing areas where everybody piles in at the wrong time. So low growth I think is here to stay. So it’s a function of not necessarily we’re all kind of trained to look for where’s the next growth opportunity, I think managements understand from our standpoint that growth is much more subdued than it used to be and they’ve got to pay attention to their cost structure.
SIMON GERGEL: I think you are starting to see that, a more balanced debate. So previously and initially the regulators and politicians were calling out for greater capital levels, lower leverage and so on, and now they’re realising that that has an implication in terms of economic growth, in terms of restricting lending, and there’s a bit more balance coming to debate about how much leverage is optimal, how much capital is optimal to allow banks to actually lend and help the economy grow rather than just to prevent risk, to reduce the risk of them losing money or. It’s not just about protecting the Government, protecting the consumers, it’s starting to be about growing the economy and lending again.
PRESENTER: So if they end up, if the banks essentially end up like utility companies with a few more cash machines, that’s going to be a bad place for them to be for the economy as a whole?
SIMON GERGEL: Well, absolutely. I mean you need banks, we desperately need banks to be lending money helping companies to grow.
PRESENTER: John?
JOHN HUSSELBEE: You know, financials represent 20% of the portfolio, I just wonder whether the guys here when they’re looking at their portfolios do they spend 20% of their time looking at financials or is it more, and has that got more since the crisis?
GARRETT FISH: Do you want to go?
SIMON GERGEL: Well I think in 2008/2009 we were probably spending considerably more than 20% of the time. I mean I think most of our time’s actually spent outside of the banks looking at the non-bank financials. I think there’s a whole range of companies there and really interesting business models and the UK’s a leader in many financial service markets, insurance, and there are some great opportunities in the UK market in that area. We spend a lot of time trying to understand those businesses. So in terms of how much percentage of time it’s probably slightly more than 20% on financials, but not disproportionate in the way that it would have been in 08/09.
GARRETT FISH: Yeah, I one hundred percent agree. Compared to three, four, five years ago, when everything was basically macro driven, and unfortunately correlations in the US went very very high, basically meaning everything is going up and down for the same reason, and it’s basically because of macroeconomic issues, whereas now those correlations have finally come down and we can kind of get back to looking at individual securities and looking at the valuations, as opposed to trying to figure out. It’s very difficult from our standpoint to figure out where’s the next regulatory kind of aspect going to come from, what are the levels going to be?
I think it’s right, I think from a US perspective we realised, kind of from a government standpoint, they probably push too far. They didn’t even actually know what levels. It’s not to discredit them, as I don’t know what is the right answer, what is too big to fail? Is there a certain number, I don’t think anybody quite knows that. From a regulatory regime where we’re going, I think they went a little too far, and then they even had to think about do we implement this? Some of those things have been dialled back a little bit. I think that’s just more of a working relationship with also the financial industry with the regulatory regime.
PRESENTER: Well, Simon’s mentioned insurers, Garrett Fish, are you a fan of insurance companies at the moment?
GARRETT FISH: I used to have a bigger overweight insurance, and that was mainly driven by Berkshire Hathaway. From a US perspective, it’s classified as an insurance company. That’s still its biggest profit pool. It’s a broadly diversified company actually. Basically we reduced our holding down to zero earlier in the year, simply on just looking at it from a price to book basis. Warren Buffett, he’s basically said I’ll never pay a dividend, because from a US perspective it’s tax inefficient because of double taxation at the corporate level, on the individual level, and I’ll never repurchase my shares. He wants to accrete the capital himself and spend it on his own acquisitions or just put back into his businesses.
So a little over two years ago, and luckily for us, this was right after we started purchasing some shares, when the share price was a little bit over one times price to book, Warren Buffett kind of came out and said I’ll repurchase shares up to 1.1 times book. He actually did repurchase some shares in that time period. The shares appreciated, they got up to 1.23, 1.24 times book, so basically we’ve found better opportunities elsewhere outside of insurance, so we’ve kind of gone, Berkshire Hathaway’s a big company, we were overweight, we took a lot of that money and just allocated elsewhere within financials.
PRESENTER: Okay, and Simon, you were mentioning, you’re quite a fan of insurance companies, what do you like about them at the moment?
SIMON GERGEL: Well I mean to be fair many of them have now re-rated. We do still have some holdings. We own Resolution in the life assurance sector and we own Hiscox in the non-life area. The non-life insurers are good companies in that they’re not particularly correlated with the economy. They’re much more to do with the insurance cycle and the natural catastrophe cycle, and therefore they have a nice diversification effect. Valuations were quite modest, they’ve now picked up to fuller levels. The life assurers again are quite a diverse bunch, but they are more linked into market levels.
One of the things we like about Resolution is it’s got a relatively low asset gearing, relatively low gearing into where financial markets happen to be. Most of its assets are unit-linked policyholder money, so the risk of return on the underlying asset goes mainly to the policyholder, and Resolution take a fee on managing those assets, and we think there’s further restructuring to go within the business, so I think there’s a bit of a special situation. I think insurance companies generally have moved to a level now which is less attractive than it was.
PRESENTER: Okay, John Husselbee, when you’re talking to fund managers and they’re buying insurance companies, does it ever worry you, because all the news that seems to constantly come out of insurance companies is it’s a series of long-term liabilities that at any given point in time half the industry’s saying could we get out of these, we’re not sure it makes sense for us commercially to be there?
JOHN HUSSELBEE: Yeah, I mean there’s choice, and of course when we’re investing we’re not only investing in the UK, we’re investing on a global basis as well. Once again, to have a strong view on a sector, on an individual stock, we might as well run the money ourselves – that’s not what we’re doing. We are selecting managers and we’re selecting their expertise to drive the returns through their alpha. There are certain issues with the insurance companies. You know, not so long ago obviously we had the cuts in the dividends as well to deal with. That would worry us particularly if we’re in a fund which may have a high weighting and potentially could affect the yield on a fund. So no specific type issues with insurance, we’re very much driving that through the fund managers that we select.
PRESENTER: Garrett, also, I suppose within non-bank financials there’s asset managers, property companies and so forth, given how volatile equity markets have been in the last few years, is now a good time to be taking exposure to companies that are a play on stock market levels?
GARRETT FISH: I think from asset managers, it’s an area within the US, we do have a fair bit of asset management companies, and even, as Simon mentioned, regarding the life insurance companies, they are more tied to equity markets, and it’s one area where we found, leave life assurance aside, but from an asset management side is they’re great businesses, high return businesses, it’s one that I will say we simply missed. We had a smaller amount of exposure there, but basically these shares have done very very well this year. So at this point in time I wouldn’t find them so attractive. Even though they are, you know, kind of going back to the question, great businesses, I just don’t find them particularly attractive right now. Part of that is because of significant bond inflows over the past three years, so that’s elevated those values as the market’s gone up, and now we’re starting to finally see some equity inflows, so you’re seeing a shift within the market. But the share prices have done very well in that regards.
PRESENTER: Simon Gergel, what’s your take on businesses that in many ways act like a warrant on the stock market?
SIMON GERGEL: I wouldn’t particularly want to have companies that are massively geared into equity market levels, and one of the things we’ve been trying to do is fund companies that are more linked to the volatility or the level of activity than the actual level of the market. So we have RG Group, which is the leading spread betting company, we have ICAP, which is an interdealer broker. Both of which are much more exposed to volatility or trading activity within markets than they are to whether the market’s high or low, and arguably they’d both do quite well if markets are very volatile. We think volatility which has been quite low is likely to pick up. Both companies again have very strong balance sheets with net cash on the balance sheet.
So that’s the way we’re thinking about it. We’re not looking to buy companies that are warrant on the stock market as you put it; we’re looking for quite the reverse, companies that are not particularly exposed to market levels, if we can find them.
PRESENTER: Yeah, and what happens when, I think in the case of one of those companies you mentioned, there’s certainly talk that it gets tied in with sort of this whole issue about what level Libor’s at. I mean when financial companies get these big fines that you hear about, as an investor in them, do you think yeah it can soak that up, or does that make a really big dent in profits, share price, not just sort of today, tomorrow but in the long term?
SIMON GERGEL: Yeah, well you absolutely have to understand where the balance sheet of the business is, whether it can sustain that sort of fine that people might be talking about, and how that will affect the business on an ongoing basis. I think the worst thing you can do in financials is buy companies that are both operationally geared, so geared to level of where the profits are very geared into the market or the economy, and also financially geared – that’s a recipe for potentially making a lot of money, but equally potentially a recipe for disaster. But if you can buy companies that have got sound balance sheets, if there’s an issue overhanging like potential Libor fines, the shares actually may well be very well cheap and discounting that risk and when that risk goes away because of a settlement the shares have potential to rally.
So when we look at ICAP we believe that it’s already pricing in quite a severe financial penalty, but it shouldn’t threaten the business from an ongoing basis point of view because of the strength of the balance sheet and because of the operations.
PRESENTER: Okay, and John Husselbee, we haven’t touched on property that much, nobody seemed to want to talk about property for years, does that tell you now’s a good time to be buying it?
JOHN HUSSELBEE: Well, property’s performed quite well the year to date, particularly with a thirst for income investors have found their way into property. The sort of property we’re investing in though, it’s quite a challenge, but through a fund, when you’re looking to try and get a pickup in yield, you have the fees and the dilution that comes from history now, and particularly when it’s open-ended funds that managers tend to keep around about 20% in cash, so that dilutes the yield straight away. I think, with bond yields beginning to rise perhaps, property looking a little less attractive than it did, if you are going to invest in property, we probably prefer the sort of secondary part of the market rather than anything else at the moment.
PRESENTER: Well, we’ve talked through some of the main subsectors of financials overall. John Husselbee, if we come to you first, within all of those, what’s one thought to leave us with? Where’s an attractive part of that market to be looking at?
JOHN HUSSELBEE: Well, financials as a whole, it is obviously clearly the sector that brought us all into the crisis. The reputation’s been quite tarnished, and because of that obviously valuations have as well. So it is a cheap area of the market and for us it’s an area of the market that we’re not going to as I said invest, we don’t have the conviction to invest in a fund, but clearly I think that as always with a recovery on the way financials lead and those managers who can pick their way through it will be the ones who outperform. I do think correlations have dropped amongst the stock markets, amongst the sectors and within the sectors themselves. We are back to a stock picking market and that the types of portfolios and managers we’re looking for are more concentrated portfolios, more stock pickers than simply people just taking sort of a more tactical overweight/underweight positioning.
PRESENTER: Garrett Fish, is that?
GARRETT FISH: I think from my standpoint banking, broadly, it’s getting back to almost like banking basics, where they’ve decreased their trading exposure, decreased the risks of the outlier, and so it’s really going back to, I don’t want to say banking is back to boring, because making money I don’t think is boring, but it’s just they’re getting back to basics as far as deposit growth, lending growth, fighting against the competitors. The macro environment doesn’t appear as it’s going to be accelerating to the upside, and really a lot of, and this is I think true for Corporate America, it’s getting rid of kind of from a cost growth standpoint, but also kind of looking at the loans, the loans that banks are putting on their books right now are very very strong loans, and so basically it’s just back to basics, and that’s fine.
So you have economic growth, you have dividends, you have share repurchase. So I think especially from a share repurchase standpoint I think we have more of that to come, I think we have more dividend repurchase, dividend hikes, and the EPS growth unfortunately is just nominal GDP growth, and a little bit of competition between the two as far as market share.
PRESENTER: Okay, Simon Gergel, is it about stock picking or getting your subsectors right?
SIMON GERGEL: I think it’s about getting the individual companies right than stock picking. I mean one of the areas that John touched on, secondary property. I think that’s one of the most exciting areas in the market at the moment is industrial property. It’s a pretty small area even within property, but you’ve seen prime properties, you know, West End offices, big shopping centres have been re-rated, investors have wanted to buy strong assets, good assets with good yield. Industrial properties have been languishing for years. There’s been virtually no build-up of supply or build-up of development.
Gradually as the economy recovers that space is taken up. There’s a big demand for logistics warehouse, there’s a big demand for data centres, which is taking up supply. And so you are seeing the levels of voids reducing, you are seeing very high yields, 7, 8, 9%, and I think that’s an area where you will see a yield shift. You will see hopefully over time the companies in there delivering good capital growth. There’s only two or three very niche players there, but they are very active management teams that we’re backing.
PRESENTER: We have to leave it there, Simon Gergel, Garrett Fish, John Husselbee, thank you very much.
ALL: Thank you.
Important information
Information and opinions contained in this interview have been arrived at by JP Morgan Asset Management. JP Morgan Asset Management and Asset.tv Ltd accept no liability for any loss arising from the use hereof nor make any represenatation as to their accuracy or completeness.
Any underlying research or analysis has been procured by JP Morgan Asset Management for its own purposes and may have been acted on by JP Morgan Asset Management or an associate for its or their own purposes. JP Morgan Asset Management is authorised and regulated by the Financial Conduct Authority.
Information and opinions contained in this interview have been arrived at by Allianz Global Investors. Allianz Global Investors and Asset.tv Ltd accept no liability for any loss arising from the use hereof nor make any representation as to their accuracy or completeness.
Any underlying research or analysis has been procured by Allianz Global Investors for its own purposes and may have been acted on by Allianz Global Investors or an associate for its or their own purposes. Allianz Global Investors is authorised and regulated by the Financial Conduct Authority.
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