ROOM TO RUN FOR FINANCIALS
Fund managers see forces lining up to support growth, Jonathan Ratner writes.
The prospect of higher interest rates and decreased regulation have already provided a boost to the financial services sector, particularly since the election of Donald Trump.
Yet those trends are likely only in their early stages, and while some of the changes are already baked into share prices, plenty of opportunities await for investors who know the best geographies, sub-sectors and companies to put money into.
The portfolio management team at Hamilton Capital Partners, which includes founding partner Robert Wessel, along with Jennifer Mersereau, Chris Dewey and Babak Assadi, consider these themes some of the most compelling in the market today.
That’s reflected in the positioning of the Hamilton Capital Global Financials Fund LP, a long-biased, actively managed portfolio of approximately 40 financial services stocks.
It’s generated an annualized return of more than nine per cent since being launched in October 2012, outperforming the global financial services index.
The fund invests in all subsectors of financial services, with positions in more than a dozen countries.
Hamilton Capital also entered the ETF market 15 months ago, when it launched the Hamilton Capital Global Bank ETF (HBG/ TSX), and expanded its offering with the Hamilton Capital Global Financials Yield ETF (HFY/TSX) in February.
The firm’s strategies are partly driven by the fact that the Canadian universe of financials is rather limited, with just a handful of major banks and insurance companies.
Regulation also happens to be an issue where Canada stands out versus its global peers, as the country’s financial industry has benefited significantly from not having the same level of regulatory pressure.
“Canada has been a bit unique because the pressure to raise capital ratios stopped several years ago,” Wessel said.
With a new government in place in the U.S., and the push toward unwinding Dodd-Frank gaining traction, that should free up capital to facilitate lending.
Wessel expects that will take the pressure off banks globally, as up until now, they’ve been forced to build capital and set it aside in case there is a problem.
“Now, the trend seems to be moving more toward the policymakers wanting to put that capital to work,” he said. “That should support bank lending growth, and therefore earnings growth.”
Wessel highlighted U.S. midcap banks as a potential beneficiary, as they’ve had to absorb fixed compliance costs off of a smaller revenue base.
The portfolio manager also pointed to opportunities in Australia, where capital has continued to build up, as well as parts of Europe.
When it comes to interest rates, some of the fund’s holdings reflect an anticipated increase at both the short and long end of the yield curve.
Wessel noted that deposittaking institutions likely stand to gain the most from rising central bank rates — the short end of the curve, while financials with longer-dated assets and obligations, namely insurance companies, will benefit from rising U.S. 10-year government bond yields.
“Europe seems to be improving, as we’re seeing a positive rate of change in GDP,” he said. “So we’re looking to find some positions that are benefiting from that, while at the same time having some element of defensiveness, depending on how the politics play out.”
Dewey highlighted the fund’s position in Lazard Ltd. (LAZ/ NYSE), a financial advisory firm that operates in virtually every major industry, along with governments and sovereign entities across the globe.
“The firm’s corporate advisory business should benefit from the expected increase in economic growth in the U.S. and Europe, and anticipated declines in U.S. regulation and corporate taxes,” the portfolio manager said.
In addition to a very high dividend yield and a history of paying out special dividends at year-end, Dewey noted that Lazard also has a strong asset management business. It accounts for approximately 45 per cent of revenues, while the firm’s restructuring business provides a countercyclical buffer to the negative earnings impact from economic downturns.
PacWest Bancorp (PACW/ NASDAQ), a recent addition to the fund, is a mid-cap commercial bank based in Beverly Hills, Calif., that is expected to materially benefit from rising shortterm interest rates, as more than 70 per cent of its loans have variable rates.
Dewey also pointed to the gains that should come from changes to U.S. tax legislation and financial services regulation.
“PacWest is very profitable compared to peers, stands to benefit from a recently announced accretive acquisition, and has one of the highest dividend yields in U.S. banking,” he said. “Given its profitability, size, commercial loan exposure, and the positive outlook for U.S. banks, PacWest could be an attractive takeover target.”
In Australia, the fund owns Westpac Banking Corp. (WBC/ ASE), the country’s second-largest bank by market cap.
Wessel noted that in addition to an economy that is forecast to outgrow Canada’s over the next few years, Australian banks have some of the highest dividend yields in global banking. Westpac is near the top of the list with a gross dividend yield of almost eight per cent.
“The country’s banking system is supervised by a conservative regulator, leading to very high capital levels — significantly higher than those of the Canadian banks, including an extra buffer to protect against housing losses,” he said.
Aviva Plc (AV/LSE) is a European lifeco that trades at a discount to its peers, and Mersereau noted that it remains a “showme” story after its takeover of U.K.-based Friends Life.
“The company continues to rebuild its balance sheet and simplify its business, including recently announced sales and strategic reviews,” she said. “Aviva’s 2016 results demonstrated significant progress, with capital coming in above management’s target range and most business lines beating expectations. A continuation of this trend should result in the stock re-rating closer to peer valuations.”