Global financials: returns, positioning and what’s next

Introduction

0:00Welcome to the Denker Capital Podcast, where our highly experienced team of in-depth thinkers and other experts share their insights on a range of investment-related topics. In this podcast, we have conversations about developments in South African and global markets and what these may mean for investors. We analyze specific stocks and sectors and explore general themes relating to the fundamental principles that underpin sound investment decisions in an ever-changing world. It's the 23rd of January and we're kicking off the year with a look at the

0:38global financials landscape in 2025. Today, Nigel Barnes is joined by our global financials team to unpack last year's returns, our positioning, and the themes that are currently shaping global financial markets. Hello, everyone, and welcome to the first Denker Capital Podcast of 2025. I'm hoping it's a great year for you all. And I'm joined today by the Denker Capital Financials team. So, Koki, nice to see you. Ben and Barry, thanks for joining me, guys. All around the boardroom table

2024 Review

1:10here and looking fired up for the year ahead. So, Koki, let's start off and look back at 2024. I had a quick look before we kicked off the podcast. The Denker Capital Global Financial Fund A-class in dollars was just a smidgen under 19% dollar return for the year. A little bit behind benchmark, but still a strong return. Koki, look back and give us a bit of feedback as to how you felt

1:43the year went and some of the highlights. Yeah. Nigel, I mean, 19%, if you told me at the beginning of the year, a lot of uncertainty. When we looked into 2024, with where the economies were going, the number of interest rate cuts that were expected, then 19% or 18.9%, I think in dollar terms, is very good. Sure. Marginally under benchmark, and that was due to the last quarter. But during the year, generally, there were some strong outperformers in Europe. I mean, shares like Erster, Barwerk, Barclays

2:18went up 65% to 70%. And something like Barclays, not the greatest bank in the world. But management will be working almost 10 years to pull it right. And we've been visiting them and we avoided investing. And we got that one right almost at the bottom and gained 70%. Same with insurers, Barri's Progressive gained 51%. US regionals underperformed relative to the performance we had there in Europe. US regionals on average make it 23%, 25%, which is all good. So all those percentages

2:51are above 20%. Where did we lose? A lot of the losses came in the fourth quarter after Donald Trump got elected. Okay. Where emerging markets got tanked. Even the euro fell 9% in a few weeks after he got elected. European banks took a knock. But generally for us, because we are diversified and we do that partly because we're trying to find value in many areas and they don't all fire at the same time. But emerging markets were a detractor everywhere in the world. And we have

3:22a small percentage in emerging markets, but like Brazil was down, I think, in currency included, like 30%, 40%. That's a big percentage down. And even India, great country, really doing well, but it was effectively flat. So yeah, 2024 was actually better than we would have hoped, but we could have done even better had Donald Trump not gotten to be president. Yeah. Yeah. Sure. Sure. Okay. Let's not get into that. But okay. All right. Well, thanks, Dougie. That's great. And give us a quick rundown on last year, as I say, strong returns. And that's

3:57great as we look forward into the new year. I mean, I joke about it. Let's come and talk about Trump in a little while. What do you see just in terms of looking around the world? I mean,

US Banks

4:09the US banks have been reporting recently. Ben, I know that's your area. How's that been looking? Yeah. Thanks, Nigel. It's been really strong, especially compared to our expectations, where from Q3, we were a bit skeptical in terms of if the growth would continue in terms of the interest rates and how quickly it would. But then I guess also on the back of Trump being elected, higher for longer narrative has really continued to play out. So from market expecting almost four to

4:40five cuts in 2025, we're now looking at one to two. Sure. Where especially with the large investment banks, that's really given them the ability to really grow net interest income in 2025. And so the guidance coming through with the four-year results for 2025 has been quite far ahead of where consensus has been. And that's been above where we were as well. We were still a bit more on the fence in terms of where the US rates would go going forward. And in the rest, it's been almost a trend from very

5:12continued drought 2024, where loan growth is still relatively low. And that, depending on which policies Trump does manage to push through, will be a potential big driver in 2025. But at the same time, net charges have been very low. Fee income has been strong. And the banks have had very good expense control. So they're all expecting strong operating leverage into 2025. So yeah, we're quite happy with the results and the market's taken it very well as well. Okay. And there seems to be quite a lot of noise about, you know, merger acquisition activity, which obviously is a good income stream

5:45for investment banking fraternity. Would you agree? I mean, is that the sort of feeling you're getting? Look, we've come from COVID, where there was a record high in terms of investment banking activity, and then it scaled down a bit. And then every year, it's been picking up. The thing is, with us, we slightly underweight the investment banks, because it's quite a volatile income stream. But look, that is a risk we talk about, because there's definitely potential for it to have a huge pickup over the next couple of years. And it's something we discuss. But I think

6:16the market does already expect it to a large degree. So we're almost more worried about it, underperforming expectations rather than overperforming. But it will definitely be a nice driver for the large investment banks. Maybe just before we end up on US banks, two things that stood out for me, Ben can comment on that. But the two big fears last year were CRE, commercial real estate. And if you recall, that people were so worried about the huge bad debt that was coming in commercial real estate and the same, the capital levels of the bond positions, AOCI was the big word. And as we warned

6:52investors, you said, you know, this panic is a buying opportunity, because, you know, all our research showed that the commercial real estate problem in the US was very limited to the smaller towns, the smaller banks, not the big banks. And just going through the results, Ben, there's almost no mention. In fact, the mention is everywhere that the provisions for commercial real estate are a lot less than expected. Yeah, no, that's very true. Within the Q1, if you look at the bank's results, I mean, we mentioned

7:23the net chart was being very low. But a lot of the reserves they took in Q1 and Q2 had picked up, and then Q3 was actually flat. And then Q4 has actually been a downward trend again in terms of reserves for commercial real estate. You can also see it anecdotally, and it's been in the news the last couple of weeks, JP Morgan saying this, the staff must come five days a week back to office. We've now seen with Donald Trump being elected, Elon Musk, the government officials must come back five days a week to the office, which was a big driver for the risk in commercial real estate, the office.

7:56So it does seem to be past its worth. Okay. Yes. Okay. In terms of the results, I mean, that's a result season now for the US banking sector. So any particular surprises or standouts there? I think we, I think the one we've taken a bigger position in recently, the one which was standing, which we had fallen back with, was Citigroup. It's a bit on the lower quality side. And they update that a decent set of results. I think SharePoint is up about 7% on results we were happy with after our recent buying. But it was interesting, it was a decent set of results,

8:30but they actually brought down their target's expectations, but it was an expectation which no one believed in. So now almost a more realistic level of 10 to 11%, which gives you enough upside. So even though it hasn't been the greatest bank, it has a couple of problems. I think we were cautiously optimistic on the results. Yeah. But I don't think there was a bank we, so far, that we own or that I've looked at, which we still, that was quite weak. So they've all been average to above average in terms of our expectations. And anything that, you know, that has excited you, that you don't own, that, you know,

9:02through this results season that you started to have a look at? Yeah. So there's two companies which we've mentioned over the last two years, we've wanted to buy, waiting for the time, as Charles Schwab and Bank of New York. And both came with good sets of results. And they, we've discussed that, again, taking positions. So maybe we'll have another round of discussions, but there's definitely a potential where you would look to take positions in those companies. Okay. Okay. You've got to do a bit of a better sales job on Koki. Well, he says he's looking at it. We'll discuss further. So I'll start with the process.

9:35Okay. Cool. All right. Thank you, Ben. Europe, Koki? Yeah, Europe. Ben can fill in the data, but essentially what we've seen so far, just this morning, Swedbank, the larger bank in Sweden, which we have seen our top five or ten. It's in, I think, eight or seven big position, came with very good results in terms of expectations. Actual results are actually flat year on year. But the market was so worried in Europe about lower interest rates, the effect of lower interest rates on bank results. And the market forgets that

10:07managements take action. You know, they prepare. They know that they see the interest rates coming down and they start moving the balance sheet. So shares up 6% this morning simply on them really meeting expectations. So Ben will give you a look at what we further expect, but that was a good result. So, I mean, no, agree on Swedbank. I think the one difference with Europe relative to the US is the banks are much cheaper, screening on an absolute value. But I think the market, because European interest rates came from negative 0.5, they were for a long time almost considered

10:42uninvestable. And then interest rates in Europe going to 4% suddenly gave them a huge tailwind as their profitability kicked up. And now the market's been quite worried that interest rates go back to zero. And that's something we don't have as our base case. And it's almost that argument that the banks trade around where interest rates expectations will be. Because if they stay around two, they're still very profitable. If they go back to zero, then rather profitability will disappear again. Not as bad as the market expects, because as Cookie says, they take, you know, that management

11:12may changes to their balance sheet to account for it to a degree. But I think that's almost the largest thing driving European banks now is their interest rate expectations. But they probably in terms of their co-operations, they're better run than they've been before. They're also sitting on huge excess capital. The dividend yields are between 5% to 8%. Bank of Ireland, a dividend yield of 10%. Markets thinking there's a lot wrong there, and there isn't. And I mean, the buybacks, some of them's up to 20% of their market cap that they've got

11:43approved for. So there's a lot of tailwinds also. So even in a worst case scenario, we still feel there's enough levers they can use to protect their share price. Okay. I'm going to get to positioning right towards the end. But I've always got to remind investors that this isn't just a banking fund. There are other sectors within the financial community that you guys look at. And one of those is insurers. So Barry, thanks for joining us. I know you look at the insurers and the big question around at the moment is the impact of the fires in the US. Just give us a bit of feedback there, Barry, as to how that looks.

12:19Sure. Thanks, Nigel. Undoubtedly a massive economic impact from the recent wildfires. And it is still an ongoing catastrophe. So any estimates are very much still very wide ranges. But the economic losses that we're seeing, sort of numbers being thrown around by economists and meteorologists, are for economic losses that's important to be around $250 billion, which if you adjust for inflation is larger than Katrina was back in the early 2000s. So a mega impact. But important to note for insurance

12:50investors and for investors in a fund is that the impact on the insurance sector and the insured industry loss is going to be significantly lower. That is estimated at the moment to be around $25 to $40 billion. You know, it's a fairly wide range, but definitely a very manageable event. And the reason for that is for years now, California wildfire risk has been very well understood and well known by our companies and the insurance sector. And risks have been elevated there. It's not a surprise that

13:21every single year since about 2019, we've had large fires. The big issue in the market is that the insurers have been unable to price adequately to take on these risks and to cover the insureds. And that is because the pricing has been regulated heavily by the state of California. So what you've seen happen there, and like you'd expect any good insurance company to do, they've simply walked away from writing that business. And an example there is Chubb, which is a core holding in the fund and has been for years. In 2021, the CEO, Evan Greenberg announced that they are stopping writing California

13:53homeowners business, which is the core business, which would cover fire loss. And I remember the call, the kind of key tagline he had on the call was that somebody else is going to have the pleasure of writing this business. So they've walked away. So we certainly think that there will be an impact on the insurance sector, and they will pay claims, but definitely an earnings event and not a capital event and very manageable. The other last part that's important is that for about five or six years now, at an industry level across all risks, losses have been over $100 billion for the

14:23insurance sector. With this at $20 to $40 billion, it's going to definitely underpin the hard market that we've seen for the last few years in the industry, which is good for insurance companies' margins and for top-line growth going forward. So that coupled with higher interest rates, I think the outlook remains pretty solid for the sector.

Outlook and Positioning

14:41Okay. Brilliant. Thanks, Barry. That's great. All right, Koki, let's look forward to the rest of this year. I'd like you to maybe just touch on positioning, just sort of take us around the world a bit. And what do you see as the sort of key themes? You've mentioned Trump. I think he's going to be a key theme for all of us, you know, pretty much every day for the foreseeable future. But how do you see it in terms of positioning and where you are right now? Yeah. So if you look at the environment, then Trump has really had an effect, and it will continue

15:14to have an effect of a stronger dollar because of the fears of tariffs and what it will do to the U.S. economy and obviously the economies America trades with. So one of the economy's worst hit is obviously Mexico as well because of him just hating it and everything that he finds fault of it. Funny enough, the Mexican banks, and we still have a small position in a really good little bank, Bank Regionala. Is that the pronunciation correct, Barry? And it's actually, Barry, I think it's up 12%

15:49this past week. So it almost looks as if the market's now decided it's all in the price. Look, the Mexican banks are starting to come with results. I think the result is due tomorrow. So the market's obviously expecting a good result, which Barry's been warning me about. But, you know, we didn't add because the macro risk is just a bit too much at this stage. But the big opportunity is starting to appear in emerging markets where we did cut back a lot during the year. And so we're really looking at that, but we'll be very cautious on that. But the valuations are attractive in

16:21emerging markets. So during the year, we'll see how it goes. The other one is obviously EU banks versus the U.S. banks. And that depends on, you know, at a certain stage, the Trump effect should have inflationary negatives, which means higher interest rates, which will prevent the U.S. economy from growing too much and even cause a recession later on. So our preference at this stage is still for more

16:51European banks simply because the valuations are on your side. So we're staying underweight U.S. banks more because, and it's still a big position, by the way, it's 30%, but it's more that, you know, they are fairly expensive, not overly so. As Ben explained, the deal flow is going to go, the interest rates are going to stay high and Trump is going to get some growth going. So loan growth will be good, activity will be good. But a lot of that is in the price. We're in Europe and the U.K., different kettle of fish, not totally in the price. And by the way, as you mentioned, it's more than this

17:27banks fund. Our two holdings that I should have mentioned in the exchanges, Euronext and Deutsche Burst, which we bought to start being defensive in case of a market fall, actually did very well last year and still looking good. And we've started adding a bit more to the debt collectors, which also in this cycle normally start doing well. So yeah, I don't know if you guys have any specifics. I think the big risk for us would be a U.S. recession and interest rates coming down

17:58sharply, which at the moment one doesn't foresee. Yeah. Okay. So portfolio is well diversified. It's well diversified. And I think it's actually, if you look at the valuations on most of it, and even U.S. compared to the relative to the market, U.S. banks are very cheap and relative to their past that fair average. But the rest of the portfolio is actually defensive with, as I said, Bank of Ireland, dividend yield of 10%, even ING, dividend yield of 6.9%.

18:28You know, that will cushion you if we do have a big negative market move. Okay. Okay. Fantastic. Thanks. I mean, just to go around the table to finish off, things to look out for this year? Barry, any specific that you feel, you know, that investors should look out for in the portfolio, things that you're maybe focusing on? I think the reinsurance sector, say, to have a U.S., I think it's been a couple of years of very difficult years up until 2023. And there was a hard reset in pricing in that market.

18:58And I think that the last couple of years have shown that the balance sheets have really been bolstered. And the loss sort of ability of these companies has improved significantly. So I think even if we have a large year, our company should still report pretty decent results and strong value growth, which I think is a change over the last maybe seven years or so for that reinsurance sector specifically. Okay. Okay. Great. Ben? I think we've discussed a lot of the operational drivers. I think the one thing we've done or started looking at is Canada more closely.

19:29I don't think we've been invested in the last 15 years in Canadian shares. And with a lot of things coming in the new potential elections this year, with a very capitalist-friendly party potentially winning and some of the companies now showing good value, we actually own three Canadian companies now. So Canada would definitely be a country we want to spend more time on. So I think that'll be something. Yeah, as I said, we haven't owned it in about 15 years or something, which I'm quite interested to spend more time on. Maybe we'll increase our positions there if we get more confidence on that.

20:02I think that's an interesting one. One of those Canadians is a smaller company and a strong potential growth into the U.S. as well. And that's where we really create the real alpha. Those smaller companies very from Arch Capital a few years ago have done really well for us. We've got something like NLB in Slovenia, Slovakia, Eastern Europe. It's really our ability to find those smaller companies. And we've got quite a few of them that we're looking at and that are in the fund.

20:35And mid-cap SEC globally is hugely underpriced. So I think investors mustn't forget those companies keep growing shareholder value at about 20% per annum and will do so even in a tough period. So I'm actually quite excited about this year. I don't think we'll do quite 20%. Never know, never know. But yeah, we should do 10% to 15% in dollars. I think it'd be... Okay. Yeah. Okay. Great. Thanks, guys. And good luck for the coming weeks.

21:07We'll get out on the road at some point. So those of you that are listening, watch out for that. And we'll put together some sessions out across Africa over the course of the next couple of months. And hopefully we'll see some of you there. But Koki, Ben, Barry, thanks for your time today. Thanks to you all for listening. And we'll catch up with you again soon. Okay. Cheers for now.

21:27Thank you for listening to this episode. We hope you found it interesting. If you would like to join us again, please subscribe for more investment insights. To find out more about our team and the funds we offer, please visit our website at denkacapital.com. For the full disclosure specific to this episode, please find the episode on our Insights page at www.denkacapital.com.