By Tom Bradley
I’m slow getting to this, but in the Report on Business a while ago John Heinzl addressed a common question from Canadian investors – ‘Why don’t I just have an all-bank portfolio?’
The question is not a surprising one given how profitable our banks are, what a powerful presence they have in our economy and how well their stocks have done. And it’s timely given questions about the impact a toppy housing market and troubled energy sector will have on the banks’ future. In his piece, however, John suggests that an all-bank portfolio is not a good idea. I concur.
Looking back, an all-Canadian-bank portfolio has indeed done well, but looking forward there are a number of things to keep in mind:
Banks are highly levered. For every dollar of equity on their balance sheets, they lend out $10-15. This leverage has contributed to the impressive profit growth over the last 25 years (leverage was higher previously), but it also speaks to why the banks have relatively low price to earnings multiples.
- As to the risk of leverage, we saw the downside in 2008/09 when shareholders’ equity was eviscerated at hundreds (thousands?) of foreign banks including some of the mighty (i.e. Citigroup, Bank of America and Royal Bank of Scotland).
- I will never forget a story a friend told me. Her parents were retired and living in Ireland. Prior to 2008, they felt the same way about their banks as we do ours, so her father had all their nest egg invested in Irish banks and insurers. After the carnage of 2008, their portfolio was virtually wiped out. (Fortunately, they had a pension).
- The Big 5 in Canada all have slightly different strategies, but they’re still tightly linked to the same economic factors: jobs, debt levels, commodity prices and the housing market. They will react similarly at times of stress.
- I’m not expecting the Canadian banks to ride off the cliff like other banks did, but they’re likely to face more headwinds in the coming years. They’ve grown in step with their customers’ increased use of debt (larger mortgages, credit cards, car loans, credit lines, home equity loans), but Canadians are now getting tapped out.
At Steadyhand, financial services companies account for about 20% of the Founders Fund’s equity allocation and are well represented in the bond component. Our managers are hoping to ride the banks and insurers’ strong market positions and benefit from the financial leverage, but they’re not betting the farm. We own the stocks and bonds in the context of a broadly diversified portfolio.