We invest on the basis of fundamental research in companies that offer quality and value over the long-term. Our four criteria for quality are a strong and sustainable competitive position, in a good and growing market, a management team with a record of value creation and a balance sheet so strong as to weather any kind of adversity. These criteria take us into companies that are involved in digital transformation, consumer products, healthcare and life sciences, and industrials. They take us away from capital and resource-intensive companies, balance sheet-driven financials and regulated businesses that rely on governments, licenses or concessions for their returns.
Our World Stars Global Equity fund did somewhat worse than the market last year because we do not own energy companies or banks. This year our fund is doing a lot better. Why didn’t we invest in bank stocks?
We invest in companies not markets and we look for companies that are resilient in the face of macro-economic challenges. Banks are highly exposed to both, which makes it hard for us to look at them as long-term investments.
There are three key reasons why banks struggle to fulfil our criteria: First, they are difficult for outsiders to analyze. As we have just seen again in the case of Silicon Valley Bank, First Republic or Credit Suisse, it is impossible to know what the assets or liabilities are given the complexity of the businesses. Second, the balance sheet of any bank is inherently unstable because a bank’s core business is maturity transformation, taking in short-term deposits and using them to make loans that are often not repaid for years. This means that any bank, no matter how large, is potentially vulnerable to a sudden outflow of short-term deposits. Third, one of the few certainties is that regulators want to increase the amount of equity required to support the assets on any bank’s balance sheet. Therefore the return on equity (ROE) of a bank is highly leveraged and at risk from externalities. Investing in banks depends on the long-term ROE that they can generate and we think that is anyone’s guess.