While investment funds focused on financial stocks, particularly bank-focused funds, have faced considerable pressure in 2020, some investors see opportunity amid the volatility.
Andrew Wessel, a longtime follower of the financial services space, is in that camp. The former portfolio manager at Sterling Capital Management is launching a new long/short financial sector-focused fund called Exegis Capital. His partner in the fund, Mick Mulvaney, has had a well-known career in Washington, D.C., having served as acting White House chief of staff, director of the Office of Management and Budget and acting director of the Consumer Financial Protection Bureau.
Wessel said in the latest Street Talk podcast that there have been many seminal regulatory and legislative changes throughout his career that have created attractive investments on both the long and short side. He believes partnering with Mulvaney offers an opportunity to capitalize on those changes as they occur.
"I can't think of anyone better to read the tea leaves, if you will, of what is going to come next from Congress or any one of the slew of federal regulators out there," Wessel said in the episode.
Many investors would like to think that the market moves on fundamentals, but unfortunately, Mulvaney said, Washington has become a larger driver of results. For instance, he noted that the market has traded heavily in recent months on the hopes of another stimulus package, the emergence of therapeutics to treat the coronavirus, and the potential for a COVID-19 vaccine.
"Politics is going to be a very turbulent thing for the near future, and I think it creates opportunities for those who understand how Washington works," Mulvaney said. "It's going to work a certain way under a Biden administration, and I think we know how that works. And it's going to work a different way under a second term of a Trump administration. I know we know how that works."
He noted that the regulatory landscape could change notably if former Vice President Joe Biden wins the presidential election. He said the recent Supreme Court ruling that deemed the Consumer Financial Protection Bureau structure unconstitutional means that if Biden wins, Director Kathy Kraninger "is finished." How the CFPB works has huge implications for lenders, Mulvaney said. He also noted that it takes a while to deregulate because the system is set up to regulate. He expects a much greater rate of change in a Democratic administration versus a Republican administration because it is easier to layer on new regulations.
"Whereas it took the Trump administration 18 months to put a new dereg agenda in, it might take a Biden administration 30 to 60 days to put new stuff in, and I don't think the market is ready for that," Mulvaney said.
Wessel said Exegis Capital plans to focus broadly on all small- and mid-cap financials and aim for a low net long/short exposure. Unlike many other financial-focused funds, though, Wessel does not expect to have significant exposure to the banking industry. Wessel noted that banks have many factors going against them. He said banks continue to trade near book value, with an expectation for mid- to upper-single-digit returns on equity. But he believes they are less "analyzable," given the high level of loan deferrals across the industry.
The investor said the coronavirus pandemic has only accelerated digital adoption and the value of some technology-focused companies. He said a slew of tech companies have recently gone public and believes some of those firms, which offer technology services to financial services companies, are attractive given their high growth prospects and favorable margins. Wessel pointed to Duck Creek Technologies Inc., a provider of core system solutions to property and casualty insurers, as an example. He said the largest insurers have tried to build internal underwriting systems on their own but argued that they often do not work.
Meanwhile, Wessel said, some other balance sheet-intensive companies have gone public and tried to command a tech-like valuation, but he thinks they could be overvalued and present a good short opportunity since they are offering a commodity product. He pointed to the IPO of Rocket Cos. Inc. as an example, noting that the company wanted a tech growth multiple on its stock but argued that it ultimately is a mortgage originator, which tend to trade around book value.
"Who really is a tech-enabled business that can grow revenue regardless of the economy environment at really high incremental margin and who really is a consumer finance company trying to show themselves as tech and get the multiple assigned," Wessel said.
"Street Talk" is a podcast hosted by S&P Global Market Intelligence.
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