June 26, 2024 By: Michael Clare |
| We believe that Canadian banks have been great investments and that they will continue to perform well in the long term. This view is primarily driven by the fact that we have a consolidated banking market in Canada, which allows the banks to generate attractive returns on their capital.
However, the Canadian banks are facing a number of challenges at this time, including rising credit losses, a weakening Canadian economy, a challenging housing market and slow loan growth as consumers and businesses absorb higher interest rates. These challenges have weighed on the sector, with the Canadian banks having underperformed the Canadian lifecos as well as U.S. financials over the past year. |
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Benefits of Diversifying Beyond Canadian Banks |
We do not believe that these challenges are going away any time soon. As such, we believe that investors in the Canadian banks should consider diversifying their portfolios to include broader financial sector investments. There are several reasons for why we believe this is the case:
1. Risk ManagementThe financial sector is subject to various risks, including regulatory changes, economic cycles, and industry-specific events. Banks are particularly sensitive to changes in interest rates, the regulatory environment, and the credit cycle, while the Canadian banks are exposed to an economic slowdown in Canada and a softening housing market. By diversifying across different sub-sectors, investors can mitigate the impact of these risks on their overall portfolios. 2. Regulatory DiversificationBanks are subject to stringent capital requirements and regulatory oversight, which can significantly impact their profitability and operational flexibility, while diversified financials have different, less stringent regulatory frameworks. By diversifying, investors can mitigate the impact of regulatory changes or competitive pressures on any single sub-sector. 3. Exposure to Different Business ModelsThe financials sector encompasses a wide range of business models and revenue streams. Banks primarily generate revenue from spread income on their lending activities, while diversified financials earn income through various sources, such as insurance premiums, asset management fees, advisory and underwriting fees, trading income, and transaction fees. By holding a diversified portfolio, investors are exposed to a wide range of revenue sources, which potentially enhances overall returns and reduces volatility. 4. Capturing Growth OpportunitiesDifferent financial sub-sectors may experience varying growth rates and opportunities at different times. For example, during periods of economic expansion, investment banking and asset management firms may thrive due to increased corporate activity and investor confidence. Conversely, during times of economic uncertainty, property and casualty insurance companies, payments firms, and companies with recurring revenues may perform better due to their defensive nature. Additionally, financial exchanges may benefit from increased volatility and higher trading volumes during periods of market stress. A diversified portfolio allows investors to participate in these growth opportunities across various sub-sectors, potentially enhancing long-term returns. |
Diversification Opportunities Across Financials Sub-Sectors |
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In addition to the above, there are specific benefits of diversifying to each of the various sub-sectors: Insurance:Insurance companies often have stable, predictable cash flows due to regular premium payments. The sector has also benefitted from rising interest rates and is often less correlated with specific banking risks, such as the credit cycle. Asset Management:Asset management firms earn fees, which are generally less volatile than spread income earning by the banks. Additionally, as global wealth grows, the demand for investment management services increases, providing growth opportunities independent of traditional banking services. Payments & Fintech:Payment processing companies earn fees on financial transactions, and these fees are expected to grow as the world continues to shift towards digital payments. Additionally, fintech firms can offer high growth potential through technological advancements and exposure to digital transformation trends. Exchanges:Exchange companies often perform well when volatility is rising, as this can lead to higher trading volumes. Since volatility typically rises when markets sell off, exchanges can act as a great diversifier in financial sector portfolios. U.S. Banks:Relative to the Canadian banks, an investment in U.S. banks can offer investors exposure to different markets, such as various regional banking markets and global capital markets. By combining investments from different financial sub-sectors with varying risk profiles and return characteristics, investors can potentially achieve a more favourable risk-adjusted return profile for their overall portfolios. This strategy reduces the risks associated with concentrating solely on bank stocks, in particular the current risks around the Canadian banks, and leverages the strengths of various financial industries. By diversifying beyond the banks, investors can improve overall portfolio stability while adding growth potential and resilience against industry-specific downturns. |
A Diversified Financials SolutionBrompton North American Financials Dividend ETF (BFIN) provides monthly distributions and the opportunity for capital gains through an investment in an actively managed, diversified portfolio of large cap North American financial services companies. BFIN’s portfolio comprises of North American Financial Services companies with a market capitalization of at least $5 billion at the time of investment. The strategy includes an active covered call writing program to earn option premiums and lower the overall volatility of portfolio returns. |
| This email is for information purposes only and does not constitute an offer to sell or a solicitation to buy the securities referred to herein. The opinions contained in this report are solely those of Brompton Funds Limited (“BFL”) and are subject to change without notice. BFL makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, BFL assumes no responsibility for any losses or damages, whether direct or indirect which arise from the use of this information. BFL is under no obligation to update the information contained herein. The information should not be regarded as a substitute for the exercise of your own judgment. Please read the prospectus or annual information form before investing.
Commissions, trailing commissions, management fees and expenses all may be associated with exchange-traded fund investments. Please read the prospectus before investing. Exchange-traded funds are not guaranteed, their values change frequently and past performance may not be repeated. Information contained on this page was published at a specific point in time. Upon publication, it is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. Certain statements contained in this document constitute forward-looking information within the meaning of Canadian securities laws. Forward-looking information may relate to matters disclosed in this document and to other matters identified in public filings relating to the funds, to the future outlook of the funds and anticipated events or results and may include statements regarding the future financial performance of the funds. In some cases, forward-looking information can be identified by terms such as “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “intend”, “estimate”, “predict”, “potential”, “continue” or other similar expressions concerning matters that are not historical facts. Actual results may vary from such forward-looking information. Investors should not place undue reliance on forward-looking statements. These forward-looking statements are made as of the date hereof and we assume no obligation to update or revise them to reflect new events or circumstances. |
Michael D. Clare
Senior Vice President & Senior Portfolio Manager
Michael D. Clare specializes in portfolio construction, security analysis, and covered call strategies with a focus on technology, health care, financials, energy, global equities, and low volatility strategies. Mr. Clare is a CFA charterholder and is a member of the Toronto CFA Society. He is also a Chartered Professional Accountant and a member of the Chartered Professional Accountants of Ontario. He received an Honours Bachelor of Commerce degree from Queen’s University.
