A look at LatAm fintechs and the future of global financials

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.

0:33We're at the start of September, and today, Nigel Barnes sits down with Barry DeCock and Corky Coiman from our Global Financials team. In this episode, Barry, who has just returned from a trip to Latin America, shares what he learned about the region's financial sector. We also look at how the Denker Global Financial Fund is positioned after a strong run this year and where the team sees the best opportunities ahead.

0:58Thank you for joining us for another Denker Capital Podcast. I'm here in the boardroom of the office and, as you know, joined by Barry and Corky from the financials team at Denker Capital. Hello, guys. I've seen you. We haven't been on a pod for a little while, I think, with the winter holidays and everything, but spring is perhaps in the air in Cape Town. And, Barry, you've just been to Latin America. How was the trip? Where did you go? Who did you see? Give us a bit of feedback. That's right. Thanks. Morning, Nigel. Yeah, great trip. So, just for the first time in two years,

1:32I didn't go last year. I made a little bit of a journey across to Mexico, Brazil, and Argentina. The intention of the trip was to catch up with some of the holdings, some of the businesses that we own in the region, but also see a host of companies we follow closely, look for new investments, and also meet with a number of private companies just to kind of get a sense of a bit of a temperature check on what's happening on the financial services sector in that region. It was a decent trip, very, very fruitful, I would say. The fintech scene in Latin America is absolutely thriving.

2:06There's two companies that have been probably the best examples of fintech disruption globally, and that's NewBank, which we own in the fund, and the other one is MercadoLibre. A new bank based in Brazil, Meli, or MercadoLibre based in Argentina. Both of those businesses have scaled significantly over the last decade, they're more or less a decade old, and they've taken massive market share from incumbents, as well as grown their books by serving the unbanked and underbanked populations in the regions. So, I think one of the key takeaways for me is that the growth potential

2:38of the region is still massive. Across those countries, particularly Mexico and Argentina, you have very big populations of under or unbanked people. So, there's a huge, huge opportunity there. The populations are relatively young, and the markets are big. So, I think those businesses are certainly powering ahead, and I think they'll continue to do so for a while. The other interesting takeaway I took from the trip is that one of the side effects or knock-on effects of these fintechs disrupting the local incumbents is that it's forced them to reinvest heavily.

3:13And over the last 10 years or so, we are now starting to see who's harvesting the benefits of reinvestment over the time, and who's done it cleverly, and who hasn't. So, you're starting to see some gaps between some of the incumbents who traditionally have enjoyed very strong market positions. Okay. One example, there's another business we own in the fund called Itau. It's a Brazilian bank. It's probably the leading quality player in Brazil, who have seen a massive improvement in ROE, so return on equity over the last 10 years, while at the same time investing heavily.

3:45So, they expect efficiency in the bank to continue to improve in the years to come, meaning that return should stay high. So, that was very good to see. And on the other side of the spectrum, you have a company like Banco de Brazil, who have potentially been a little bit slow to reinvest, and are dealing with a whole host of other problems. And I think the divergence between the two companies is becoming wider, and it's going to become more difficult for the follower to catch the leader, if they like. Yeah. Okay. Okay. We're going to get on in a second and talk a little bit about

4:16positioning in the fund and what you guys are doing across the broader fund. But Barry, in terms of the Latin America position, how big is that position at the moment? So, it's pretty small. It's 2.5%. The valuations in the region are very attractive. But, of course, it's Latin America. It's emerging markets. There's always going to be an element of political or macro volatility. So, I think, you know, as excited as I am coming back from the region, it is something that we will manage with position size. So, unlikely to go too big in a position like that,

4:48because we are very sort of cognizant of the risks that come with that. Okay. Okay. Great. Nigel, if I come in there, it's interesting. Like, I think my own first visit to Brazil was in 1995, as I'm getting my age away here, and seeing Ito and Modesto. There were a lot of other banks in at that stage. But so, what's important is that we've been following the big banks, although they were then smaller, obviously, for 25-plus years. And so, what is fascinating to me, just chatting to Barry now on this return,

5:23is you can just see the cultural differences between banks, how that grows and stays. Like, Ito was always the best bank, and they're still the best bank. So, that whole philosophy of reinvesting, a bit like Capitec in South Africa, you know, it's just the culture at management level of how we do things and how we keep growing versus, let's say, Barry mentioned Bank of the Brazil. It's always the one that has bad debts. You know, it always looks cheap, and you're tempted to buy some because it's cheap.

5:55But if you look back 10 years later, you always need better with staying with the very good quality companies. And that's why these trips are so worthwhile, just to touch base again and to make sure, you know, of what we see in the companies that it's still there and it doesn't change. Yeah. Okay. Brilliant. Thanks, Cookie. Thanks, Barry. Thanks for that update and the good timing on you returning from Latin America. Let's just have a – I mean, I was looking this morning at the figures, and, you know, the data is obviously important. The Denker Capital Global Financial A-Class year-to-date,

6:28up 25.5% in US dollars. So, a cracking year. That is almost double MSCI World, 10.9%, I think that's right, and your benchmark is somewhere in the region of 17.5%. So, guys, it's been a good year so far. That always makes me, you know, I'm putting myself in the mind of investors think, okay, you know, now what happens? You know, we've still got a few more months to go in the year. There's quite a bit of uncertainty around, you know, in global markets. So, I'm really just interested today to really portray a message

7:03to listeners about what you're doing now because I'm sure you've got some of that in your mind. So, Cookie, just set the scene for us as to what you're thinking at the moment, and then we can dive a little bit deeper. So, yes, look, we are very pleased about the performance, but also the last five years have been astonishing.

7:23Investors must bear in mind that the low point was after COVID. So, you're coming off a very low base, and I'm very glad to say that we were urging investors to say, yes, invest and stay invested because the valuations were just so attractive. So, you're quite right. Especially European banks and the U.S. investment banks have rallied hard. And so, most still show some upside, but obviously not the same we had a year ago, two years ago.

7:54So, Barclay is still trading at below book value, below the capital that's invested there. I think it's 80% of that 0.8. And what is fascinating in this last 10 years, managements globally have really been forced to focus on cost control, better net interest margins, lower bad debts. So, all of them are targeting much higher future return on capital than they've had in the last 15 years.

8:27Okay. Now, okay, that's management forecast, and that's why we go on these visits to just test that. But so, what we've gradually been doing, we, as good investors, skeptical, so we're not going to pay up for the promises. So, gradually, we've been, like JP Morgan was our largest position in the fund, a 5% plus position for, I think, three years. And we've gradually been whittling that down. JP Morgan's now the most, the valuation is the highest it's been in 15 years. And so, that does, but the others, as I said, Barclays, HSBC, ABN AMRO

9:01still show upside. But the ones that have rallied very hard and starting to look dear, we've started moving into basically three areas that have lagged. And Barry can talk a bit about them, but the one is we've covered already emerging markets. So, we've gradually moved into the emerging market banks that have lagged and specifically were hit hard again by Trump's tariffs. Like, slapping 50% tariffs on Brazil, slapping 50% on India. The Indian macro outlook has dimmed a bit.

9:35Not much, because India is an unbelievable country with high growth rate. But the banks, like Shiram Transport Finance, down 17% this year. So, that's where we add selling some JP Morgan, going into some Shiram, going to more ETO, adding a bit to new banks. So, our emerging market position has been increasing. Similarly, within the U.S., we've shifted from the investment banks and also from the European banks a bit into the U.S. regional banks.

10:08So, and by the way, those regional banks are now these days multi-state, actually national banks. So, they're still referred to as regional banks. But they have lagged large banks. U.S. Bank Hall is now our largest holding in the fund, 5% plus. It's actually, for last year, the price was flat. Even this year, it's still lagging now. So, it's really dependent on interest rates. So, as interest rates come down, those banks will start rallying. And then the last one, maybe Barry can just update us there, is on property and casualty.

10:39Investors have been with us for many years. We'll know that it was big in the fund. It did very well. And we reduced that a bit. And starting to look at that again, Barry? Yeah, sure. So, the property and casualty or PNC insurance sector, as Korki says, has always been a fairly sizable portion of the fund. Over the last year or year to date, it has lagged border markets. Now, firstly, that's something we would expect when markets are very strong. It tends to be less correlated to the economic or market cycle and more correlated typically to what happens with the weather.

11:13If there's large hurricanes or big floods, then these guys tend to struggle. And if not, they tend to do well. So, year to date, for two examples, we'll kind of put it into perspective. Two big holdings we have. The one is called Chubb and the other is called Arch Capital Group. Both of those businesses, the stock prices year to date are essentially flat, while six months, over the first six months of the year, they've grown their book value, which is a good proxy for the underlying value of the business or the intrinsic value of the business by 11% and 12% respectively for Arch and for Chubb.

11:43So, the businesses are still growing, their returns are still high, and we think that's likely to continue. One of the reasons that the market has also rotated a little bit out of them into the other more rate-sensitive names is around concerns of margin compression. So, as Koki said, they've had a few very good years, given that the insurance pricing cycle has been very strong, which means their margins have been very strong. And it is going to decelerate. That's natural. It can't continue to improve forever. But we think the market is a little bit overly pessimistic

12:13on how much it will decelerate. Plus, we still have high interest rates globally by historical standards, which supports the investment income of these businesses. So, we're still pretty confident on the long-term outlook for them. And because they've lagged, we're adding to it, as Koki said. Okay. I think what hopefully comes through to listeners and investors is that we continuously have a lot of factors to – but the factors we focus on, firstly, foremost, is the quality of the business, shown in its track record.

12:45And then, obviously, each business operates within a geopolitical – but geopolitical, like Argentina, is high risk at the moment. You're really excited as what could be happening there, but we start very slow and just watch it. And you're always concerned about the geopolitical thing. And then, you know, the valuation. And so, the lower the valuation, the more attractive it becomes if the quality is there and the geopolitical risk is there. But, importantly, position sizing in the fund.

13:18So, that's why Brazil and Mexico are at the moment only 2.5% because of the uncertainty surrounding there. But, as we get more certainty, you know, we can increase that. And that's really – maybe one other thing very important is our ability, because of our 20 years of – of 25 years of doing this, is just to quickly identify future winners. And, you know, that's always – Ben went to Canada earlier in the year and found one or two really exciting smaller financials in Canada.

13:50And the one that just reported yesterday, very, very good results. And, you know, so we keep on looking for those smaller players, take a small stake, continuously visit management. And so, if you look over the last 20 years what the fund has done, it's had a good year, but, you know, I don't lose a moment's sleep about the next five to 10 years. You know, maybe the next three months had a good run. Maybe you have a bit of a pullback in the market. But by the end of next year, you know, be very happy with what –

14:21you know, the ability of the companies to keep generating growth in their shareholder value. I mean, that was going to be my sort of final question, guys, really, is outlook in terms of – you know, if I'm looking at my investment statement now and I'm seeing 25-odd percent in dollars, you know, where do you think you'll finish the year? What's your outlook over the course of the next 12 months? Yeah, so the big uncertainty at the moment is basically two things. The one is short-term. It's will the Fed start cutting interest rates?

14:51And by the way, if it doesn't cut because growth remains too strong, that's good news because then your U.S. growth is strong. The U.S. growth is surprising positively the whole time. So your interest rate outlook – but it is true when short-term interest rates come down, it is generally good for asset prices. But the other concern of the markets is just – and us as well – is long bond rates. So your 10- and 30-year yields are climbing because markets are very concerned

15:21about the debt levels of Japan, of the U.K., of France, even of the U.S. So in the U.S., Trump's actions with tariffs does bring in extra tax revenue. It does create jobs. And so there's a lot of uncertainty. And so we'd expect the market to – it's always – when you've had such a run, maybe you should have a bit of a correction, which might be healthy. But by the end of the year, we definitely expect to be higher. And by the end of next year, in line with the past 10%, 12% every year.

15:56And every then third year, you have a really good year. We have another 30%. So definitely with valuations and the visits we're doing to the companies, how strong they are, I'd be surprised if we didn't have another good 12 months. Okay. But I mean, your core message, Koki, is that you're taking a little bit off the table with some of those winners and investing in some new opportunities where you see some value. And obviously with that quality focus and everything, as always. So, okay, great. Thank you, guys. We're actually going to put this in an article, which is going to be posted on the Denka website.

16:30So thank you, guys, as always, for your insight. Barry, welcome back from your long trip from Latin America. And good luck for the rest of the year. Thanks, Nigel. Thanks, Nigel. Thank 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.

17:00For the full disclosure specific to this episode, please find the episode on our insights page at www.denkacapital.com.