Three financials with an enviable growth outlook

Welcome to part three, of our ‘super’ sector series of the Australian ASX300 excluding the ASX50 stocks. Over the coming weeks, Monique Rooney and I are going to be producing a four-part series that will look at four groups of the market and put them into correlated groups.

1. The innovators,
2. The cyclicals,
3. The financials, and
4. The defensives

So far in parts one and two, we've heard about 'Innovators' and 'cyclicals'. Now, Monique Rooney and I are taking a look at 'Financials'.  Watch or read below as we explore some of the current themes, risks and opportunities, portfolio considerations, and the long term winners in 'Financials'..

Transcript

James Abela: Hi, I'm James Abela, the portfolio manager for the Australian Future Leaders Fund for Fidelity.

Monique Rooney: Hi, my name is Monique Rooney, and I'm an analyst and an assistant portfolio manager on the Australian Future Leaders Fund.

James: Today, we're going to talk about the Australian Mid and Small Caps Super Sector Series, Part Three, which is financials.

Monique: So financials are typically the banks, they're insurance stocks, and also the diversified financials.

James: So the current themes really in banking. It's quite tough. There's not a lot of long growth, and there's also some scale in the regional banks, so that's quite a low returning universe, whereas the exciting ones is really Netwealth (ASX: NWL) and Hub24 (ASX: HUB) and Pinnacle (ASX: PNI), and those D-fin specialists are really winning market share, high-returning, compounders, and they're really offering something different to the market, which is a lot of technology but also high level of service.

And then the insurance brokers are also going quite well because they've got a hardening insurance cycle, they're long-term compounders, and they're still winning market share and delivering a good service to their customer base, so that's really the key themes that currently operate in the financial space.

Monique: So where we see the opportunities is typically in those financials that are higher return, they're structural growing businesses, they're taking market share, or they can create a differentiated product in what is a crowded marketplace.

So for example, the fintechs and the wealth managers, so Netwealth and Hub24 taking market share, or be it the asset managers, a company like Pinnacle that is growing its stable of asset boutique managers. It's a scalable business model, and they continue to accumulate assets, and their boutique managers deliver above average performance returns.

James: So the real risks... I think the number one big risk is that they all sell trust. You got to remember in financials ultimately, much like medicine, legal, engineering, and finance, you ultimately sell trust, so the biggest risk is really trust, which comes back to regulation, and that's really the risk right across the universe, so if you can provide trust and a really high level of service consumers keep coming back to, that's really where the big opportunities are. That's where the risks and opportunities kind of come together in this space.

So when you're constructing portfolio in this space, I think trust is still one key thing you need to think about, and what are you ultimately selling? 

And that forward really drives the return. So when you have a really deep level of trust in this universe, you can have a very high return that's quite persistent, but if you don't and your product offering is quite commoditized or heavily regulated, your return profile is much lower, so that really, I guess, limits what you can achieve in this universe. You really need to have something that really, really stands out, otherwise it can be regulated down or commoditized out, and then therefore you have quite a low returning business, which can be often subscale, and that means the return profile is just going to be quite poor.

So the long-term winners are really those that can establish that trust. They can have high returns, they can have really good market structures, really good products that are very differentiated, so they are really asset managers and specialist niche services, such as insurance brokers, that really have high returns and end up being multi-year-long term compounders, and that's really the ones that are the long-term winners in this universe.

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