The objective of the portfolio is to provide long-term capital growth by investing in financial companies from around the world. This feeder fund portfolio primarily invests in participatory interests of the FSCA approved Denker Global Financial Fund, a sub-fund of the Irish domiciled Sanlam Universal Funds plc. The portfolio may also hold ancillary liquid assets including cash and/or money market instruments. The Portfolio may, where the Manager considers it in the best interests of the Fund, invest up to 100% of its net assets in securities traded in or dealt on the stock exchanges or regulated markets considered by the manager to be emerging markets.

Market review

Global equity markets performed well over the quarter. On a total US dollar return basis - the S&P 500 Index gained 9.0%, the MSCI World Index 8.6% and the MSCI Emerging Markets Index 11.8%. The surprising decline in long dated developed market bond yields that started in Q1 reversed in the final quarter of the year. Yield on US 10 year maturity government bonds increased from 1.7% at the end of Q3 to 1.9% at the end of Q4. The yield on 10 year German bonds, which had fallen to -0.6% at the end of Q3, closed the year at -0.2%.

In December President Trump became the third president since America’s founding to be impeached. Nearly all Democrats voted in support of the two articles of impeachment - abuse of power and obstruction of Congress – but they failed to attract Republican support. As Republicans control the Senate and a two-thirds majority would be required to remove Trump from office, a conviction seems unlikely.

In the UK election in December, the Conservative Party secured the biggest majority since 1987 - an unexpected landslide after relentless campaigning on the promise to “Get Brexit Done”. The majority will give Prime Minister Boris Johnson greater leeway to steer future trade talks.

Portfolio review

The fund outperformed both the MSCI World and MSCI Financials indices this quarter (and in the process the A class generated a 20.6% return in US dollars for the 12 months ending December 2019). It was mainly the factors that detracted during the first three quarters of 2019 that turned in our favour in Q4. These were investments outside the US (UK, Europe and emerging markets) and smaller companies. The market seemed to turn more positive towards smaller companies (or value) and the fund’s investments in TCS, LIC, Bank of Georgia, Regional Bank (Mexico), Sparebanken Nord (all outside the US) gained strongly.
Throughout 2019 (and in fact the past decade) investors preferred the certainty of the US (higher US growth and interest rates) – but this changed in Q4 2019 (and hence the fund’s outperformance). In Q4 the US dollar weakened (+/- 4%), UK financials gained (+/- 17%) after the UK electorate handed Boris Johnson a decisive majority, and India, Mexico and Russia gained strongly (for different reasons). The rerating of the “off the beaten track” smaller and midcap companies is good news. The fund is invested in a number of smaller/midcap financials who are using technology to their advantage to gain market share and who, despite good shareholder value growth, have been ignored.

Amongst our top 15 performers, we would rate only one (Qualitas in Mexico) as expensive in the medium term. The others remain significantly undervalued.

Changes to portfolio and outlook

Many strategists are forecasting that the ROW (rest of world) GDP growth will pick up and exceed US GDP growth. Yet US financials remain relatively expensive, which is why we’ve maintained our stance of 60% invested outside the US. The countries we are invested in are all in healthy shape in terms of their debt to GDP and budget ratios, so the investments in the fund don’t need any of the countries to engineer a turnaround. Obviously an improvement in the current situation will help a lot, specifically with Europe, but should US growth indeed disappoint it should lead to a weaker US dollar which will lead to increased capital flows to emerging markets and this would further benefit the fund (over and above our base case scenario).

The exposures to various geographies have remained largely the same since the beginning of 2019, but we have made a few large individual additions:

- During 2019 LIC Housing Finance (India) was significantly de-rated due to the liquidity and confidence crisis in India. Our meeting with management in November however confirmed that it is unaffected and gave us the confidence to increase our holding significantly. Investors have already benefitted from this and the share price could double again over the next two to three years.
- We also increased our investment in ING (Netherlands) and invested in both Swedbank and ABN-Amro. All three banks were subject to investigations regarding system weaknesses that allowed client money laundering. Again, management visits confirmed our research that the market is overreacting to a once-off fine and the possible costs of systems upgrades. With share prices 20-30% down, we viewed these as superb investing opportunities. European financials are undervalued but these three are now particularly cheap.

Our top 10 retains large exposure to the US of which Citigroup and AIG still have significant re-rating potential as does Essent (a smaller US mortgage insurer). An investment in an asset that compounds consistently at a high rate is sure to generate good investment returns over time.
But often the market goes through phases when for a while these principles are ignored.
This is when patience is needed. The worst mistake one can make is to change from a proven strategy when it hasn’t worked for a few years. Sure, there are times when one should question whether the market sees something that you’re missing... maybe the market foresees the end of banking as we know it! But our meetings with managements of the quality banks and insurers show that they are well aware of the risks and working hard to right size their operations and through digitalisation strategies remain ahead of challengers. History teaches us that investors tend to over-react (both on the upside and on the downside) as they confuse momentum with quality.

The banks and insurers we are invested in are compounding shareholder value. The fund is invested in a good spread of smaller high growth challengers and larger well established players benefitting from their scale advantage, across a number of economies. There’s considerable upside potential ahead for the patient investor.