DIGIT Digest: Insights from a Financials Analyst

In this episode of DIGIT Digest, Rebecca Maclean sits down with Alex Potter, Investment Director at Aberdeen. Rebecca and Alex talk about current market conditions, geographical and sector opportunities, risks and challenges, income and dividend opportunities, and much more. Listen now!

Transcript

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Podcast from Aberdeen Investment Trusts.

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Rebecca Maclean

Hello, I'm Rebecca Mclean. Welcome to Digital Digest, a podcast where Ben Richie and I discuss UK and European equity markets and the outlook for Dunedin income growth. Today we're delighted to be joined by Alex Potter, financials analyst at Aberdeen. Can't wait to dive into the discussion. We're going to talk about how Alex approaches his investing in this complex sector, and how companies can navigate the important macro drivers facing them, which are often outside of their control.

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And we're going to discuss the key themes facing the sector, where Alex sees the most compelling investment opportunities at this time, and how Ben and I look to gain exposure to financials in DIGIT. So welcome, Alex. 

Alex Potter

Hi, Rebecca. Thanks very much. I've not had somebody say I'm excited about investing in financial stocks for an awful long time.

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So thanks for the great welcome. 

Rebecca Maclean

Well, I'm looking forward to the discussion. So, Alex, I mean, you joined the firm in September last year. So you haven't been here for long, but, you've done a lot of work during that time on the sector, and it's been incredibly helpful for us to be able to have you as a team member to discuss what's going on in the sector.

00:01:19:11 - 00:01:42:17

So maybe you could start with telling us a bit more about yourself and about your career progression and what brought you to Aberdeen? 

Alex Potter

Sure. So, I've been looking at financials for, more time than I'd like to admit, but it's over 20 years now. Mostly on the sell side as it's known. So that is working for investment banks, advising lovely companies such as the one I'm now lucky enough to work for.

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So in fact, if we go right back into sort of demand distant past pre the financial crisis, Ben was a client of mine many years ago. So, I've spent an awful long time looking at the financial industry, mostly within investment banks. And then more recently I did 5 or 6 years in a strategy consulting business.

00:02:03:16 - 00:02:25:11

And I'm quite a big believer in this adage of, and I need to source who actually, came up with this adage. But if you can't explain what you do for a living to your mum in one sentence, you don't really understand your own job properly. So, what I always used to explain to my mum is, I look at financial services companies, work out whether they're good or bad, and write research about whether the share price is going to go up or down.

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Then when I when I went into strategy consulting, it was basically, I looked at financial services companies, worked out which ones were doing well and badly and tried to help the ones that were doing badly. Now I'm sitting here with you lovely people at Aberdeen. It's exactly the same kind of process. So the output now is helping you guys achieve performance for our shareholders in things like DIGIT.

00:02:48:00 - 00:03:13:12

Rebecca Maclean

Yeah. So, we’re very lucky to have you in the team and you sit alongside, sector analysts who, have global coverage of their sector remit and is really helpful resource for the portfolio managers. So maybe you could start with, a bit about sort of where you sit and also your responsibilities within the DM research team.

00:03:13:14 - 00:03:34:21

Alex Potter

Sure. I have to say, it's been one of the sort of pleasant surprises about joining the firm is I didn't realize the sort of number of people that we have looking, who are purely sector analysts, looking at sectors across the globe, working in sort of several of our investment teams and also the sort of the intellectual horsepower that there is, there's an awful lot of smart people.

00:03:34:23 - 00:03:56:11

I think it's probably always a good life life goal to have, to just work with people smarter than yourself. So within that, I sort of lead on global financials, as the analyst within the developed markets equity team, which means I look at banks, I look at insurance companies, and I look at any other sort of financial services companies don't quite fit into those two classifications.

00:03:56:11 - 00:04:20:15

I've got a lovely chap called Samuel who, who works alongside me. Within the developed markets equity team, we’re obviously equity focused and I think about my life is more bank focused on UK, Europe and the North American markets. But within that we have companies like ones that I'm sure you know well Rebecca: HSBC, Prudential that have significant businesses in overseas territories.

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So therefore you have to keep an eye on what's going on in sort of Latin America across Asian markets. And that's really sort of helpful working with some of our teams, such as the global emerging markets team and our Asian teams at a specialist in those areas. So really, one of the things I'm trying to do in my sort of first months and weeks in the job is bring together all of those pools of knowledge so we can work, I think, to the better effect of the end client.

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Ben Ritchie

Alex, do you think we can maybe sort of explore a little bit about what you're looking for when you're looking at a bank or an insurance company or an asset manager, what are the kind of key characteristics that you sort of build your analysis around? Yeah, I mean, in short, predictability is probably the key thing that I like to look at.

00:05:04:14 - 00:05:24:08

Alex Potter

And I mean, let's let's take a step back for a minute Ben. In a sense, finance is a very mature industry. And in a sense, in essence, I mean, the Medicis popularized banking in Florence in the 1400s. There was something called the Mesopotamian shekel, which is the first sort of widely recognized form of currency, which were 5000 years old.

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So in that sense, finance has been around for ages. And sitting sort of here in the UK, it's an everyday part of life. But if I tell you only 24% of the world's population have a credit card, I don't know anybody. I don't think that doesn't have a credit card. It makes you realize that in some markets finance is very mature and that sets its own particular characteristics at the industry for that market and in other markets, finance is actually really quite immature.

00:05:51:22 - 00:06:17:16

And the other thing that's changing within that Ben, is the actual shape and nature of finance changes, as for example, state pension provision might fall back as, populations age as we have different challenges in sort of long term health care. There's all sorts of financial challenges that come from that, that drive really how we look at investing in the financial services industry.

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And so within that, as I sort of began with my overriding aim here is to find predictability. And often that manifests itself in finding companies that have got good market shares, good product base, maintain good customer service. Capital adequacy is obviously key for all financial services companies. We both lived through the sort of painful experiences and some of the failures of the financial crisis.

00:06:44:01 - 00:07:08:17

We never want to go there again. So therefore, I think about quality and the size of that capital base that these companies might be sitting on their relations with regulators, how belligerent their regulators are towards the companies. There are still some markets where regulators really are quite light touch. And if we if we look at the recent change of administration in the United States, I think regulations begin to become increasingly light touch over there.

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That therefore means I have to think in slightly different terms relative to a regulator, such as the ones we have here in London. That regulate the banks and the insurance companies really quite tightly. So once I've sort of got a handle on what I think of what you might call the quality or predictability of these companies, then you can drive down to what's your actual financial return going to be for, for them.

00:07:30:13 - 00:07:51:07

And that's going to be either a function of their sort of market share shape, the growth of the market they’re in. The absolute level of interest rates is really important for a lot of banks and insurance companies. So that, for example, at the moment plays really nicely into the UK market, where interest rates are relatively high compared to most of the rest of continental Europe.

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And all of that flows through to ultimately, my aim is to find a company that's going to pay me a stable, growing dividend. That is not going to scare me, that I know I can buy a share, put it away for 3 to 5 years and sleep comfortably at night, and one that's going to give me some capital return.

00:08:07:09 - 00:08:24:01

And actually still plenty of opportunities out there. I mean, not just the sector. Both banks and insurance companies have had a pretty good run in the last year or two. They had a terrible run for as much as 15 years before that. So I don't think this sort of positive market for a lot of these companies is nearly over yet.

00:08:24:03 - 00:08:48:16

Ben Ritchie

Could you sort of maybe tease out a little bit what has changed over the last 2 or 3 years from the sort of previous period? I mean, you only have to go back, I suppose, to sort of 2020, and you had regulators intervening to basically force banks to stop distributing dividends back to their investors. So what sort of changed over the last couple of years in comparison to what we saw during the maybe the ten years leading up to up to Covid?

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Alex Potter

So the big changes in the last couple of years have largely, and there are a range of changes in the sort of ten years that you alluded to that are running into Covid, where we saw improvements in regulation and we saw much greater capital bases forced into the bank. So they made a much better and more stable sort of industry to look at.

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What then change subsequent to Covid was really inflation and the level of interest rates, and that ended up with that actually, in some sense, is quite a happy confluence. Much as nobody likes to see the price of eggs going up quite so quickly every day, it's given us quite a happy confluence of, for example, in the UK, significantly higher interest rates than almost any point we had in the 2010s at a time when the banks were pretty well capitalized, they pretty well regulated that much more sensibly, run businesses.

00:09:39:24 - 00:09:59:17

And they once were they much less ambitious. And so this is going to sound like an odd thing to say when lots of people are looking at companies in other sectors like the the Nvidia and the Novo Nordisk in this world, they've got incredibly ambitious growth plans. If I see a bank or an insurance company with incredibly ambitious growth plans, I'm naturally scared.

00:09:59:19 - 00:10:22:17

These are mature industries. I think you create much greater value by that. Sticking to that out, I just spoke about a few minutes ago around predictability, giving yourself that predictability of return from our investment is really derived from understanding which banks are going to be able to generate a predictable return out of their own operations. So what's really changed 

00:10:22:17 - 00:10:40:03

the last couple of years for the banks really is how sensible many of them now look, and if you think I'm some sort of bank apologist or not, I mean massive skeptic of most of these businesses, and I think that's a very healthy position to take as an analyst.

00:10:40:05 - 00:11:00:12

But the absolute level of interest rates and the underlying level of economic growth of many of the sort of European economies is really manifestly different from what we saw pre-COVID. 

Ben Ritchie

And maybe, I guess, in terms of the sort of sector and what would you you really identified a couple of things there, but what would you sort of pick out as the the kind of key themes you're concentrating on?

00:11:00:14 - 00:11:24:07

Alex Potter

Yeah. Key themes. I mean, there's a, there's a few that I think we've already touched on slightly here. I mean, your overarching drivers of profitability for banks tend to be the level of economic growth, the GDP growth that you're seeing in their economy, the absolute level of interest rates. And then as long as unemployment stays nice and low, then you don't generate yourself a bad debt cycle.

00:11:24:09 - 00:11:41:07

And then the direction of rates remains the the sort of final parts of it. If rates are going to go up, then we can probably take a view that growth is going to slow for that economy. Growth is going to slow for that banks balance sheet and that probably introduces a little bit more rate stress into the customer base of that bank.

00:11:41:09 - 00:12:03:17

All of those things tend to be early indicators that the cycle is coming to an end. And actually, oddly, in a sense, banks are typically late cyclical animals. Now, that sounds slightly odd to say, because all of those things I've just painted for year round slowing loan growth, increasing stress in the balance sheet would make you naturally perhaps a little more cautious about these things.

00:12:03:19 - 00:12:24:15

The reality tends to be that by this point in the cycle, banks tend to be churning out really good dividends. You're seeing really strong shareholder returns coming out of them. And the growth slowdown hasn't yet impacted. So that's why the outperformance in equity market terms tends to be after the sort of go go growth companies,

00:12:24:15 - 00:12:55:13

The Googles and the Nvidia's of this world have started to see the strain of higher interest rates and their share prices started to underperform. That's the point where the banks tend to outperform, for example.

Rebecca Maclean

Yeah, we could to start to dig into some of the companies. Alex, in your coverage. And we've introduced NatWest to DIGIT in the in the last year, which you know, fits with the investment objective of the trust, which is to look for companies with resilient income and, attractive total return.

00:12:55:15 - 00:13:15:00

but you see, you've mentioned a number of those aspects in terms of what you're looking for in the banking sector. And I think sort of NatWest does tick a number of those boxes. You know, they had pretty good results recently talking about some growth across their three divisions, personal, commercial, private banking. Now they're focusing on simplification.

00:13:15:00 - 00:13:36:01

I suppose that speaks to the returns which are higher than they've been for a number of years at the bank. And that alongside a strong balance sheet to supporting an attractive distribution yield to shareholders in the form of dividends, but also buybacks too. So yeah, NatWest is is you know, the UK retail bank that we have in Dunedin.

00:13:36:03 - 00:14:10:23

But maybe you could talk a bit more about some of the subsectors and geographies and where you see the most attractive opportunities across your coverage. 

Alex Potter 

Yeah, sure. Great question Rebecca. I mean, in terms of geographies, I think the UK is is an absolutely pivotal economy at the moment. As much as you can sometimes argue, the press llikes to talk down the UK, relative to what we're seeing in some of their continental European countries, we are pretty politically stable at the moment with a government that isn't in an easy position but certainly isn't doing anything too cavalier.

00:14:11:00 - 00:14:28:24

And you've also got this higher level of interest rates, which tends to be quite beneficial. And the last thing to sort of cover off there is unemployment still remains pretty low and GDP growth remains pretty good. So the UK is a sort of key place that I look at. There are also some interesting, places to look from

00:14:28:24 - 00:14:54:05

a purely banking perspective across southern Europe, Spain and Italy both got some pretty good banking statistics going on at the moment. And at least part of that is because those two economies or the banking crisis happened to them in such enormous size and were then hit by the sovereign debt crisis only about 3 or 4 years later, if you remember, that sort of kicked in in 2012, 2013.

00:14:54:07 - 00:15:14:12

These guys have been through the wringer in a way that even the UK banks haven't, so that their recovery potential, when they start to get themselves back on their feet, is so much greater than even what's left in the UK. And I do think that's a good recovery, potential remaining here in the UK. NatWest a great example of that.

00:15:14:14 - 00:15:37:10

And the sort of final part to cover off there is the US and this is always a tricky one because you've got good GDP growth in the US, you've got relatively high interest rates. And as somebody smart were saying to me recently relative to the valuation of the US stock market, US financial services companies are, incredibly undervalued relative to their own market.

00:15:37:12 - 00:16:05:06

However, if you look on a like for like basis, the valuation of say on NatWest against, JP Morgan, JP Morgan is nearly twice as expensive. So there's such a big valuation gap between what we see in the US equity market, what we're seeing in European equity markets now, that makes it quite hard for me to sort of sit here in London and and recommend getting too excited about some of the US financial services companies, even though that is often the rhetoric from that domestic audience.

00:16:05:08 - 00:16:31:03

In terms of subsectors, Rebecca, I mean, anything linked to demographics tends to be a very good market at the moment. You've seen businesses like the Prudential, with increasing sort of penetration of life insurance business throughout its Asian network. You've got some businesses, such as Aviva, which is one of the UK's preeminent, non-life insurance company. And non-life is a terrible term in that sense, property casualty to our American cousins.

00:16:31:05 - 00:16:54:18

But the kind of insurance company that looks after your car and your home contents and all of that sort of stuff, Aviva’s been building a great business, increasing penetration there. And actually parts of its business are helping companies that are trying to de-risk their defined benefit pension schemes. And that is a whole demographic trend that's took an awful long way to go, both here in the UK, some of the European markets and importantly in the US.

00:16:54:18 - 00:17:21:19

There's a there's a big insurance company called MetLife in the US. It's one of the leading players in that market over there. So while you can see some sort of demographic or market structure change, such as here in the UK, defined benefit schemes are offered to almost nobody in the private sector anymore. That's been a huge change in our long term savings market over the last 10 or 20 years, and the final subsector that's interesting is sort of analogous to that, which is the wealth management sector.

00:17:21:20 - 00:17:42:19

As people are starting to have to be more self-reliant for long term savings, people are thinking in more aggressive terms about how they provide for their own retirement and how they then manage the wealth that accumulates through making those efforts towards long term savings. All of those things together mean some really interesting little growth opportunities. Even at sort of NatWest.

00:17:42:19 - 00:18:05:19

And I almost said sleepy old NatWest. I shouldn't be so disparaging about a company that I like, but as I said, I see financial services companies with aggressive business expansion plans and I'll actually get quite nervous. So I like companies that are rather more conservative. Even at NatWest, for example, they've got a pretty good little wealth management business growing, and that's an incredible opportunity for the UK banks.

00:18:05:20 - 00:18:29:22

NatWest got something like 15 or 18 million customers here in the UK, and it offers wealth management services to really very few of them. And there's an enormous untapped potential for a lot of the big incumbent banks to really offer better wealth management services, perhaps working with companies like Aberdeen to help them with their investment process to really help the UK save for its long term retirement.

00:18:29:24 - 00:18:53:24

Rebecca Maclean

So you've talked about some of the growth opportunities that you see across the sector. But I mean, it's not typically known as being a growth industry. And, you know, you said actually you'd be scared if you did see huge ambitious plans for growth at the sector level. But when we think about the, I suppose, the risks associated with looking for quality ideas within the sector, you know, it is a sector which is economically sensitive.

00:18:53:24 - 00:19:15:03

There's regulatory scrutiny on the names. You know, you've got sort of compliance regulations, but you've got cyber security as a risk as well. And so maybe you talk a bit about about some of those red flags that you would look for when you're identifying quality income names in the sector?

Alex Potter 

you're exactly right. This is definitely not a sector without risk.

00:19:15:05 - 00:19:46:11

In terms of economic sensitivity, what I tend to say great store buys, those companies that that perhaps grew a little less what, perhaps a little more conservative in their business models in the good times tend to be the ones that aren't run over quite so aggressively, by an impending recession. Point 1. Point 2 - in terms of regulation and compliance, you can get an awful lot of sense about how well or badly these companies are doing, not simply by looking at how much they might get fined in any given period of time.

00:19:46:11 - 00:20:07:19

And it remains a sad fact that most banks get fined for something most years. But also by the quality of the dialog that they have about their regulatory and compliance procedures and the quality of that dialog with the regulators. So occasionally I do go and talk to regulators when they're willing to talk to me about who defined to be the banks are the most open.

00:20:07:19 - 00:20:31:02

Who do you communicate with most frequently? Where do you feel as though the risks really lie within your sector? Within the sort of sector which you regulate. And I can then sort of pass that information across into what I think about the quality characteristics of the financial services companies that I look at. You point out an interesting one there about cyber security as well.

00:20:31:03 - 00:21:06:23

And I'd be cautious. I mean, having just lost my outlook email address, all of this, weekend, I’d be cautious about necessarily saying that cyber security is anywhere near unique to banks. The risk of financial fraud, like cyber security, is obviously quite a lot bigger because the the numbers involved tend to be quite high in those places. But really cyber security is a risk in all sectors for all of us these days, and it's beholden on us, I think, to take control of our own security a little bit for the banks they’ve been regulated from the perspective of cyber security, for something like the last 12 or 14 years here in the UK.

00:21:07:00 - 00:21:28:19

So some of the regulators have really been on this very, very early on because banks were at the leading edge in many ways of putting computers in the workplace. Some of the first places you saw big mainframes operating within the corporate environments in the UK, with things like companies that faced off at the stock exchange, the history of technology within financial services is incredibly long.

00:21:28:19 - 00:21:56:14

So in that sense, some of the security arrangements of these financial services firms is right up there at the leading edge. And yes, you're right in in companies like NatWest, where they have a retail bank, a corporate bank, probably a number one bank for the smaller mid-sized business market here in the UK, as well as having a wealth management business, what you might call the attack surface, that is possible for hackers to try and go after within these firms is really relatively large.

00:21:56:16 - 00:22:23:00

The thing is, these banks have been talking about these risks for years now, and you can just open the annual report and have a look at the number of pages where they write about cyber security. These are definitely red flags that we need to keep an eye on as analysts and as investors. But it's certainly one with one that we're not blind to, and it's one where we ask for regular updates from all of the companies that we look at.

Rebecca Maclean

Alex just jumping back in on that discussions that you have with the regulators.

00:22:23:00 - 00:22:44:23

I think that's fascinating, being able to pull in that sort of insight to your stock selection. And you've mentioned about us maybe sort of going through a period of deregulation, sort of any thoughts about the UK regulator or maybe UK and European regulators and, and sort of your feel for how the regulatory landscape will be evolving for the banking sector?

00:22:45:00 - 00:23:12:07

Alex Potter

Yeah, that's a great question. I mean, I spent most of last week, Rebecca, speaking to probably 2 or 3 banking CEOs per day. So an awful lot of meeting notes I’m trying to pass through at the moment. And the regulatory approach of the different, both national and regional regulators, be it in the UK or for example, Italy or the ECB, which regulates banking more widely across the EU, is really in an interesting spot right now.

00:23:12:07 - 00:23:51:10

I think it's clear that the Trump administration is going after deregulatory agenda and the news over the weekend about having some sort of strategic cryptocurrency reserve is only indicative of quite how aggressive that could look. The interesting thing, for example, the regulatory agenda in the UK is they've already pushed back one of the big changes in the rulebook, something which revels in the terrible abbreviation, FRTB, the fundamental review of the trading book, which, without wanting to send anybody to sleep while they listen to this podcast, is more around trying to measure the risk within the the trading floors of the investment banks here in London.

00:23:51:12 - 00:24:09:10

That rulebook has been pushed out by another year already here in the UK, after the evidence that was coming out of the US, that they are either going to push this back a year or two, authorizing the bank completely. Now, that actually looks a little bit different within the EU. So I've talked to sort of several EU banking CEOs in the last week.

00:24:09:12 - 00:24:37:24

And they say much as the European system of regulation is really good in some senses, and that you very rarely get anything that goes on that is too crazy. They will not be a crypto currency reserve at the EU level any time soon, for example. It also means that there is a degree of stability around that regulatory regime, which may mean that the drive to deregulate within the EU actually runs more slowly than here in the UK.

00:24:38:01 - 00:25:00:04

That is potentially an opportunity for the UK banks themselves. But going after what's the most aggressive business model you can get away with within the regulatory boundaries that you're painted is not the kind of investment that I come to work in the morning looking to buy into. I don't like banks with aggressive business models. I don't like insurers with aggressive business models.

00:25:00:06 - 00:25:23:04

Put very simply, so much as regulation has been a complete one way street since really 2007, in that regulations have just got tighter. The interesting thing now is what the US is doing under the new administration is the first step back in the other direction that we've seen at any point in almost last 20 years. So is this a turning point?

00:25:23:07 - 00:25:42:21

Such that, we're going to go through 20 years of deregulation. I very much do not think it will be, but it's the fact that you're starting to see little regional differences that alters the outlook for some of these companies, which is something we really have to stay on top of quite closely.

Ben Ritchie

I guess one of the things I like is when we, when we think about financials is that, you know, it's incredibly broad space, isn't it?

00:25:42:21 - 00:26:09:09

And, between yourself and Sam, you know, you're covering everything from financial software companies through to, I guess, UK mortgage lenders. Could you give us a bit of a sense of how you might sort of think about some of those different subsegments and where where you might find interesting opportunities across that range? 

Alex Potter

Sure. I try not to sit here and really be too subsector focused.

00:26:09:11 - 00:26:43:00

If that's not a slightly unusual thing to say, purely because I think you can have very good companies in sectors that look by themselves to be a little more muted in growth terms, and then you can get much more growth. Interesting sectors where you have a range of quite poor companies that are failing to execute particularly well. So my sort of abiding driver in everything that I try to do is thinking about the quality of the individual company, rather than just trying to be some sort of top down screening, smart beta sort of machine.

00:26:43:02 - 00:27:07:06

What we're looking at at the moment that we find interesting, however, is, for example, private markets investing. The company called Intermediate Capital ICG that Sam has written on recently, that's one of the world's preeminent private equity and private debt businesses. That's just in fact, just earlier today closed out another one of its recent funds, blowing all sorts of fundraising records out of the water.

00:27:07:08 - 00:27:32:09

This is an interesting new area of the market that what you might call non-bank finance. Now, regulators are already starting to look into this market. So it is certainly towards the higher end of the risk spectrum. But within that business, it's not a market that's brand new. It's a market that existed for many, many years. And there's some high quality companies that have made good returns for their shareholders for a long period of time in that market.

00:27:32:11 - 00:27:57:10

I certainly think there's some froth in certain areas of it, but companies like ICG seem to have a very good model, well optimized, good track record and a very, very strong brand with its investor base to really drive growth out of the private markets business. Another one in wealth management that I alluded to briefly there Ben. There's some, I think, really strong growth available out there in wealth management world.

00:27:57:12 - 00:28:28:05

The difficulty is that one of the world's most preeminent wealth managers is UBS, and that has its own travails, having rescued Credit Suisse. Another one is Morgan Stanley over in the US, which I think is a fabulous company but is also fabulously expensive at the moment. So wealth management is a little subject I'm really interested in, but trying to find anything that I think offers us value as investors and can generate a good return in the next sort of one, three, five years for our client base is is pretty tough right now.

00:28:28:07 - 00:28:47:24

And that brings us sort of back to, should we say, some of the sleepier businesses and in a sense, being a sleepy business, it's often meant that your your stock valuation can look somewhat forgotten. So NatWest a year or so ago, looked incredibly forlorn. And in that past year the share price has nearly doubled. And I think still think there is more to go for there.

00:28:48:01 - 00:29:06:18

Theres companies like a Aviva that have been through the wringer on a few different transformation efforts more recently. They've got a great management team that I just met last week, and they're starting to produce some really good growth and they're talking a very good capital return story. And you've got a great dividend story out of this business along with it generating incremental cost savings.

00:29:06:20 - 00:29:26:10

So sometimes the subsectors I like to look at and sometimes are just individual quality companies I'd like to look at. I think probably the key to being a good financials analyst is being able to retain that degree of agility and not get too hung up on trying to use your assets and be a top down investor as they were.

00:29:26:12 - 00:29:48:09

Ben Ritchie

Absolutely. I think it's one of those things where it's very tempting, isn't it, in the space to get very focused on the things you probably don't know much about, like what's gonna happen to interest rates next? And these sort of all the other things where you, you know, you have a much greater level of insight. Sure. 

Alex Potter 

Do you know what Ben, if I knew what direction interest rates were going to go next, I think I'd be, I'd be living on my Caribbean Island, speaking to you from across the umbrella on top of a margarita.

00:29:48:09 - 00:30:08:16

But, I'm not really smart enough for that. 

Ben Ritchie

Absolutely. The thing might also be interesting would be how you sort of pull that together when considering income in your kind of investment cases. And again, maybe for our listeners, you know, how might we sort of see from here the kind of income story developed from financials, maybe banks in particular?

00:30:08:20 - 00:30:28:08

Alex Potter

I think you're in in a really, really great little spot in this cycle from, from an income perspective for banks. Banks generate capital every day. Insurance generate capital every day from their existing businesses. What do they do with that capital. But fundamentally they've got two things they can do. They invest in new business or they should give it back to shareholders.

00:30:28:10 - 00:30:50:11

And at the moment, interest rates have risen. And many would argue GDP growth is going to slow a little from here. In most developed markets, economies, that's an area where the strain of having to invest in new business is actually not that great at the moment. So that gives you more of that free cash flow from your business that you can put back to remunerated shareholders.

00:30:50:13 - 00:31:08:20

If we look at Aviva as an example, I just mentioned a few minutes ago, you've got a dividend yield from them that is now up into the high single digits. They're also talking about returns via other methods as well. And all the while that is because they're harvesting the benefits of having spent a lot of money on technology and innovation.

00:31:08:22 - 00:31:45:10

They're still in markets which are generating them a little bit of growth. And and they've gone interestingly for the M&A approach. And obviously in the middle of to by direct line, one of the UK's other big motor insurance companies, Direct Line, has had a very tough time over the last few years. I think they could be getting a really good business at a pretty good price, and that's going to give them the ability to then improve shareholder returns again out of bringing their sort of their expertise and technology and running these businesses efficiently to the direct line family of businesses.

00:31:45:12 - 00:32:07:23

So really at this point in the cycle where rates have gone up a lot, banks and insurance companies are harvesting quite a lot of the benefits of that. And that's why you're seeing pretty good dividend yields in lots of the places. There's a big bank in Italy called Intesa Sanpaolo that is one of now continental Europe's preeminent wealth managers, is one of the few wealth players that I think in Europe has still got a value case around it.

00:32:07:23 - 00:32:26:23

You're getting a dividend yield in double digits out of that, and they are still generating a little bit of a growth in their balance sheet every year. So there's some great opportunities out there.

Ben Ritchie

Maybe just sort of turning to the sustainability angle. It sort of worries me a little bit to say this but we are sort of heading not that far away from AGM season.

00:32:27:00 - 00:32:46:08

And I guess one of the things that always marks out, I think costs a little bit differently to a lot of our peers is that our fund managers and analysts, though themselves supposed to have been done by a central team, we kind of be interesting what you think might be some of the sort of controversial areas or the areas that might be occupying you a little bit more as we as we go through that period?

00:32:46:08 - 00:33:04:09

I mean, traditionally there's normally lots of debates around pay. Be interesting to get your get your thoughts on on some of the areas that you think will be interesting. 

Alex Potter

Yeah. So I think you're exactly right. I mean, financial services firms fundamentally are, people businesses. So for the people, a gender is really vital to you in many ways.

00:33:04:09 - 00:33:31:08

They don't have supply chains in quite the same way as, say, a fashion retailer might. But you do have to get your people agenda right. And that comes down to an awful lot of aspects, such as looking at your your pay divides, looking your opportunities, your diversity, equity and inclusion agendas, looking at how diverse your board looks and one thing that I do find is, is much improved over my sort of 20 years looking looking at these businesses.

00:33:31:08 - 00:33:52:08

And unless you get around a NatWest bank in its own form, annual report from 1977, when I first came and worked in the city and it was a board of, I think, about 25 or 30 directors at the time, every single one, a white male, you just don't see that anymore. And I think that's been a big improvement in the sector.

00:33:52:10 - 00:34:19:13

And that's not only some sort of degree of tokenism going on a board level. You're seeing that up and down these organizations. So I think that they've improved quite a lot. The aspect that the market hasn't really got its arms around yet. And the world of academia, I sort of spent some time do a course at Cambridge a couple of years ago, because this is something that interests me very personally, is around how we think about what are called financed and facilitated emissions.

00:34:19:13 - 00:34:44:01

What do I mean by that? Banks lend money to people. If those people are building coal fired power stations, that's probably not great. What do I mean by facilitated emissions? Well, if you do a bond issue for somebody that wants to build a coal fired power station, that's not great as well. Now, these are examples of very simplistic, but for example, the big bank in France called BNP Paribas, thats got a big network all over sub-Saharan Africa.

00:34:44:01 - 00:35:11:12

And one of the things BNP has been engaged with its local regulator and the ECB about is the fact that they are trying to help out a lot of the African grid, which in many ways electricity grid, which in many ways is completely nascent from being people using paraffin stoves in their own homes and people having electricity where they have it, often from coal fired sources, moving that into something much cleaner, like gas.

00:35:11:14 - 00:35:32:15

I mean, under the current European rules, that's really tough for them to do without taking a capital penalty, even though that probably for the planet is to the net benefit. So there's still some niceties to go through around understanding the impact of banks on the environmental part of that agenda. Fundamentally, banks, the banks are like the bloodstream of the entire economy.

00:35:32:15 - 00:35:59:11

They touch everything. They're everywhere. It doesn't mean they're to blame for the entire economy, but they can certainly help direct capital around more sensibly. And regulators are actively engaging with both banking and insurance industries about how we approach the environmental part of the sustainability agenda. From that perspective. But to your point Ben, yeah, you're right. I mean, pay the people agenda is probably what's going to generate the AGM season upcoming.

00:35:59:13 - 00:36:17:10

What interests me, the longer term is exactly how banks or financial services sit at the center of what you might call a sustainable finance revolution. 

Ben Ritchie

Yeah, absolutely. Alex. And again, I think that's something that the sort of dropped off the agenda has and to some degree and probably and since Mr. Trump's elevation to the presidency again is probably you pushed further to the right.

00:36:17:10 - 00:36:38:02

But it doesn't necessarily mean that some of these things haven't gone away as major issues to be, to be thinking about maybe, maybe just a final one. As a we've been relatively long suffering investors in Prudential. It's not been the greatest performing financial investment over the last couple of years. Could you give us some thoughts on on how we might see that one turn out from here?

00:36:38:03 - 00:37:06:14

The reasons for optimism. 

Alex Potter

Yeah. Prudential has been in a tricky spot. I mean, the the business model of offering life insurance to customers in Asia, where life insurance penetration is relatively low and where margins are pretty good. That business model sounds entirely sensible. Sadly, they walked into the chainsaw of Covid in many ways because an awful lot of their business is based out of China and Hong Kong, and a lot of it was based on, travel.

00:37:06:16 - 00:37:33:10

Therefore, when travel was banned and there was obviously a very large change in the base in the Chinese economy in the same way that was over here in the UK, they had a pretty tough time of it. Now, has that growth fully reignited in the way we hoped? Well, not quite yet, because China is then gone on to have something of a commercial real estate problem, which is again having dampening and impact on the sort of investment appetite of consumers out there.

00:37:33:10 - 00:37:52:19

So I think the Pru been through a pretty tough period of time. And I think you still have some issues to work out in terms of, the commercial real estate market over there, and only on Friday with the CEO of a bank that has a very big business over in Hong Kong. And he said the, well, how did he term it?

00:37:52:22 - 00:38:14:03

I think he said it was something like the gradual decompression of the Chinese economy is actually being relatively well managed this time, in that it hasn't precipitated any financial crises anywhere. When I think that also still means is that could be a little more what you might call decompression to come out of that market. So I don't think Pru will have actually turned the corner quite yet.

00:38:14:09 - 00:38:35:13

But I think the long term story for an investment like a company that's aiming specifically at life insurance, the penetrate to market remains pretty well intact. But excellent. So that's good to hear. Keep us in the keep us in the stock for a little longer. Flew.

Ben Ritchie

Well, thank you very much. That's been a real comprehensive approach across the field of the financials.

00:38:35:13 - 00:38:52:15

We've covered the Medicis, the Mesopotamian shekel. We've talked about NatWest annual bills in the 1970s. So I think we've covered we've covered a lot. We've even managed to dip into some of the features that we're looking for in investments, in the opportunities and upside that's out there in the market. So, you know, it's a it's a fascinating space.

00:38:52:17 - 00:39:10:15

Always has been perhaps, you know, as diverse as it ever has been as well. And, you know, opportunities, all over the place for those who are prepared to, to do the work. So thank you very much, Alex. It's been that's been fantastic.

Alex Potter

Ben, Rebecca, thank you. 

Ben Ritchie

And if you'd like to find out more about Dunedin Income Growth, you can visit our website.

00:39:10:17 - 00:39:27:00

On www.DunedinIncomeGrowth.co.uk  and please don't forget to like and subscribe to the show on your podcast platform of choice. Thank you very much.

00:39:27:02 - 00:39:54:01

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00:39:54:03 - 00:40:15:05

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00:40:15:11 - 00:40:20:21

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