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Roger Edgley

Banking on growth

09 April 2015

The banking sector offers opportunities in the developing nations, according to Roger Edgley of Wasatch Advisors.

While unpopular with politicians and the public, banks have also been out of favour with investors – developed market banks, that is. As investors, we are very keen on emerging market banks which, we believe, can be excellent long-term growth stocks.

Banks are necessary for the healthy growth of any economy, and emerging market economies in particular have prospects for long periods of robust expansion. While many have had their own debt and currency crises, some were able to sidestep the 2008 crisis that tarnished so many banking reputations elsewhere. For example, the financial system in India, where the central bank restricted real estate lending before 2008, suffered relatively little.

Growth engines

Another difference is that developed market banks are often burdened by legacy branch networks, risky non-banking activities and strained capital ratios. Emerging market banks, on the other hand, can remain real engines of growth in their economies, expanding along with the increasing success of their customers, whether these are SMEs (small or medium-sized enterprises) or individuals.

‘Credit penetration’ is a measure of a financial system’s maturity and one of the key bank metrics we watch. In developed economies, mortgage lending can be more than 100% of GDP. In countries like the Philippines and India, where most homes are bought with cash, it is less than 12%. So the banks that engage in prudent lending have plenty of opportunity to grow there.

Some of this growth can be achieved with the kind of technology that eliminates the need for bricks-and-mortar branches. In India, for example, a number of banks offer mobile banking applications, including the ability to transfer money using PIN numbers generated on users’ mobile phones. In addition to relatively conservative business practices and efficient use of technology, emerging market banks can maintain attractive returns on equity without the dangerous levels of leverage often seen in developed markets.

We concentrate on countries where banking can be a strong factor in the growth of the economy. They usually have favourable demographics, expanding middle-class populations and low consumer debt-to-GDP ratios. They are also likely to have independent regulators, rational central bank policies with relatively stable currencies, and good political environments for business and entrepreneurship. India, Mexico, the Philippines, Indonesia and even Thailand are good examples.

Traditional banking focuses on the long-term financing needed for infrastructure and factories, homes and cars. So if we’re right about a country’s growth prospects its banks, as a sector, are almost certain to do well. Our job then is to pick the ones that will maintain or increase market share, while running a prudent credit-risk strategy to avoid major bad loans.

Smaller and stronger

We have little interest in the big banks, which often have government ownership, and are generally attracted to mid-cap businesses. Some of the top performers are medium-sized, with particular niches such as SME and mortgage lending.

We look for banks with strong IT systems. That gives them leading-edge efficiency in service delivery and allows low-cost delivery of services to even more customers through, for example, ATMs in rural areas and even on boats. And we also look for higher-than-global-average returns on assets and equity, lower non-performing loan ratios and stronger capitalisation ratios. By focusing on quality banks, we believe we can reduce our risks substantially.

Our favourite emerging market banks, which are currently in the portfolio, include India’s Axis Bank, Bank Rakyat Indonesia and Thailand’s Kasikornbank. India’s HDFC Bank is not currently in the portfolio because its market capitalisation is too large for the fund, but serves as a good illustration of the kind of performance that is possible for emerging market banking stocks. Over the last 10 years, HDFC Bank has achieved an average annual return of around 27%, and it has significantly outperformed both the Indian stock market and the widely watched MSCI Emerging Markets Index.

More broadly, banks have been some of our most successful emerging market investments for over a decade. And we still see plenty of runway ahead of us.

Roger Edgley of Wasatch Advisors is the manager of the St. James’s Place Emerging Markets Equity fund. The opinions expressed are those of Roger Edgley and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.

Past performance is not indicative of future performance. The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.


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