How this CIO turns inefficiency into opportunity
Westpac Private Bank's Chief Investment Officer George Toubia shares his big-picture views on markets.
Note: This episode was recorded on 28 June 2024.
Markets have become far more complex over the last few years, and the information available to investors daily is becoming more overwhelming. Every day, it seems there is a new narrative, or a new flavour of the month in financial markets - and more often than not, the price action in those themes is fleeting.
While this information is excellent news for market transparency, the speed by which that information is processed can make opportunities quickly crowded for investors.
George Toubia, Chief Investment Officer at Westpac Private Bank, seeks these out these inefficiencies and identifies the actionable investment opportunities they present.
"When we think about market structure or improper understanding of the opportunity, if we can really identify them as early as possible but in a very thoughtful manner, it gives us enough room to help our clients benefit," Toubia told me.
The place where Toubia is finding the most inefficiency today is in private markets. However, a disciplined approach to understanding where to derive optimal risk-return is key.
An illustration of this is the generational opportunity within the credit space for alternative lenders. Toubia has defined 2024 and 2025 as a “watershed moment for intelligent capital”.
This view has emerged through declining global liquidity, ongoing capital adequacy regulations, reduced lending capacity from traditional providers and tighter credit conditions. Toubia observes that inefficiencies are also evident within private market asset ownership.
"If you have the tenacity, the discipline, and the patience to find these companies, quite often you will find really high-quality organic growth in businesses that don't have a lot of leverage, that are highly profitable, and can do more for their customers.
But most importantly, can acquire them or be part of their journey at a valuation that is very reasonable, and not using financial engineering as a way to create the outcome," Toubia said.
To walk us through this fascinating opportunity, Toubia sat down with me for the latest episode of The Pitch.
Edited Transcript
Can you explain what investing in inefficiencies means?
Toubia: The world of investing is not straightforward, and one of the major impacts of data, speed of information, ease of access of information, minute by minute being accessible to us is that capital is moving very quickly towards suddenly understood and popular opportunities. That in itself is a two-edged sword.
One, it's an excellent acknowledgement that the opportunity you're pursuing is good, you'd hope. And second, the scale of it can deteriorate the quality of the opportunity with time. We are, as students of looking after our clients in a thoughtful manner, we are constantly thinking about opportunities that exhibit the following attributes.
Either, they sit in market segments that are ignored by broad participants, yet have some strong positive structural drivers to them, or [we are] looking at market segments where there is a complete misunderstanding of the underlying opportunity and it's highly overlooked.
Those two things, if we can identify them as early as possible but in a very thoughtful manner, I think it gives us enough room to help our clients benefit from that, where the quality of that risk-reward is really strong before it becomes understood.
What are one or two of the biggest inefficiencies you are seeing today?
Toubia: There's plenty, to be honest with you. First of all, market structure, in my mind across the world, is the biggest source of inefficiency. I'll give you an example.
In the world of private markets, in the world of supporting private businesses through the lens of private equity, we have always centred our focus on growth opportunities around small and medium-sized businesses.
Now, those businesses, irrespective of the country, generally represent one-third of the economy, very powerful. What defines them is these are businesses that have an enterprise value of less than $1 billion. They are hard to find. They're not organised like a large company, but they have a very strong thesis for their customers. Yet because of their small size, they generally are not the focus of large private equity investors.
If you have the tenacity, the discipline, and the patience to go and find those companies, you can find high-quality organic growth in businesses that don't have a lot of leverage, that are highly profitable and can do more for their customers, but most importantly, acquire them or be part of their journey at a valuation that is very reasonable and not using financial engineering as a way to create the outcomes.
That's an example of market structure where we constantly find opportunities because of the fragmentation, the small sizes of those markets, and the lack of attention of large capital.
You've spoken about 2024 and 2025 being a watershed moment for "intelligent debt capital". What does that mean?
Toubia: We have been early advocates of the alternative provider of capital opportunity, which is now very well understood by markets today. We've been advocates since 2013, and we launched that thematic for the benefit of our clients. We've been on this journey for about 10 years now.
What is defining this watershed moment now, from our point of view, is that there's never been a moment in time where these regulatory hurdles that we've been living with for the last 10 years, are not only present but are likely to get more intense regulation in the US through the Basel III end game, which is yet to be implemented. It's going to be more strict on the banks in America when ironically, most of the major banks in America are flushed with capital.
The irony is that regulation is going to become even tougher now following a regime change from abundant liquidity to tighter liquidity. The number of lenders in America has declined by 30% since 2022. Then, you have an increasing number of the banking system community in the US, such as the small banks, busy dealing with their existing books for obvious reasons.
On top of that, there is a significant amount of debt in the commercial market that needs to be refinanced. So between 2024 and 2025, there's going to be US$1.5 trillion of loans that need to be refinanced.
When you think about the intersection of those variables, there's never been a period in our mind where the demands and the important role of alternative lending done correctly has been as productive as the regime that we're in today.
Why is it so important that deals in the SME corporate market are done correctly and what does that look like to you?
Toubia: Lending may come across as an easy business. It's not. Whoever says lending is an easy business probably has not done that for a long period.
For us, it's important not to be enticed by generic opportunities and accept loose covenants and loose protective features that come with that lending opportunity, simply because the environment today is offering you close to a double-digit yield on that opportunity.
When we think about lending, firstly, we think it's important to be targeted in a specific market structure. Secondly, it has to be done in the right structure, and thirdly, it has to have the right skills. If I work backward, we look for the right teams that have been cycle-tested, have done lending over multiple crises, and know how not straightforward it is sometimes to get paid back and refinanced, and we only look for organisations that can roll their sleeves up and take control of the underlying asset.
Should something go wrong, it's easy to lend but it's not easy to get it back. We need those extra skills in case something goes wrong with a company or a real estate project. You need those attributes.
The structure has to be right because lending in those private settings is private and liquidity mismatches are not correct. And giving people a false sense of comfort that they have intermittent liquidity is not good, especially when people need it because that's when times are very demanding. Getting the structure right is very important. And going back to what part of the market is important for us because we think small/mid-markets represent areas where the quality of the opportunity is very robust.
You can sit with a company face-to-face bilaterally and negotiate the right risk-reward with the right covenants. If you are in the larger segment of the markets, including private credit markets, there will be a lot of competition and not only will the upside deteriorate, but also the features and the protective aspects that come with it will deteriorate. That's why we think it needs to be done through the right lens to benefit from it through cycles in a sustainable way.
How are you locking this opportunity down?
Toubia: For us, being a private bank based out of Australia and understanding the importance of our clients' need for familiarity and comfort zone with markets, clearly our theme has foundations in Australia. And we're doing that in multiple market segments.
We've been doing that in real estate for about 10 years, and we moved into the world of small mid-market corporates about a couple of years ago where there are extreme inefficiencies where suddenly if one of the major banks is unable to lend a customer for regulatory reasons, there are no obvious alternatives for that.
But in the US, we've been active in that space for about eight years because the US has got a depth that is disproportionately much larger than any other market. There is also a strong legal system that is tested every day in terms of enforceability of security and collateral, and whilst the market is so large, it's usually focused on the larger opportunity set, so it leaves an abundance of inefficiencies in those markets.
For us, Europe is not that critical at this stage in terms of the opportunity, but I have to say in places like Southeast Asia where credit is still scarce in general, we talk about our banking system where net interest margins are 1.7 and 1.8%. In some parts of Southeast Asia, in the traditional banking sector, [NIMs] are 3 and 3.5[%].
It speaks to how there is a complete disconnect between the demand for credit due to thriving demographics and the supply of it there. The opportunity is very strong, but we are alert that the enforcement of structure, security, and entitlement is not straightforward in some markets where the rule of law is not fully tested for the benefit of the lender. We park that until that regime becomes a little bit better. But for now, we're very busy in the US and Australia, and we think that opportunity in that specific market segment has got durability.
To find out more about Westpac Private Bank’s Global Investment Services, visit us here.
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...
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