Investing in financial services operators

During 2017, a number of local companies will be seeking to raise capital as the end of exceptionally low interest rates becomes more imminent. Hard pressed investors have suffered in the low interest rate regime over the last few years as they had few opportunities to get a decent return for their capital without taking undue risks.

Some financial services operators fret about the high risks that some investors take when in their search for yields they buy any financial paper that offers a return significantly higher than the low interest rate paid by local banks. Clearly, the link between risk and return is still misunderstood by many unsophisticated investors.

Another important development that will evolve in the coming years is the increasing awareness of younger people of the need to start saving for their retirement as the consequences of an unfunded national pensions system become cruelly clear. But putting all your eggs in one basket has never been a good strategy for investors looking for long-term capital appreciation and a decent annual return.

One option that local investors have adopted for many years is investing in the financial services sector. This sector is predominantly represented by banks, two of which dominate the local market. Local banks did not go through the trauma of having to be rescued by taxpayers because their loan books did not turn sour in the financial crisis that started in 2007.

The introduction of the Single Supervisory Mechanism has in many ways made local banks safer. A valid argument is that the two bigger local banks are investment grade rated and, although new regulation will have an impact on their profitability, they still offer a relatively safe bet for investors with a moderate risk appetite who take a long-term view on what to expect from their investment.

It is clear that the ECB wants all banks under their supervision to increase their capital to levels that may seem high to many. But this is exactly one element that makes bank stocks and bonds safer. Prudence in banking is never a wasted virtue.

Hard pressed investors have suffered in the low interest rate regime over the last few years

Another direct effect of tighter regulation is that banks are investing heavily in their risk management function. This will ensure that in all areas of operations, from lending to IT management, there are always strict directives that banks have to follow to ensure that their depositors’ and shareholders’ money is kept safe at all times.

Some brokers argue that local banks should give more information about their present and future strategic and operational plans to shareholders and bondholders so that they can assess the future prospects of their investment. It is no secret, for instance, that the regulators are insisting that EU banks need to update their business models to ensure long-term sustainability.

Banks and other quoted companies should keep their shareholders and bondholders updated on their plans at least on a twice yearly basis, especially when they have plans to issue new equity or bonds on the market. Intelligent investors will value the straight talk of leaders in this sector on how they intend to make their organisations safer where value is added gradually over the medium to long-term.

It would be short-sighted on the part of investors to take their decisions based purely on the bond coupon offered by private companies that are not rated, only partially regulated, and where the quality of the management is only superficially assessed.

It needs hardly be stressed that investment in equities or complex financial paper like convertible bonds is not the best option for everyone. Many investors have a very low risk tolerance and rely on the preservation of their capital almost at all costs. So one would do well to discuss with a trusted and well-informed independent financial adviser before taking important investment decisions.

But for those who look for long-term added value in the form of capital appreciation and a decent annual return through dividends or interest payments, investing part of their savings in the financial sector could be a viable option.

Even if the local stock market is rather shallow, the bigger listed companies often have enough daily turnover to make trading in their stock adequately liquid. The publication of listed companies’ accounts is another opportunity for investors to gauge the future prospects of the stocks they target for their possible investment.

The management of these companies would do well to keep their communications to the market simple, comprehensive and frequent.

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