By John Hadwen, August 2, 2018 How has the global Financials sector fared in the first half of 2018? Here are my key takeaways on the recent performance of North American and European banks, as well as what we expect may be in store for each. Signature s long-term investment thesis that U.S. banks could generate superior dividend growth from the lows of 2010 is playing out and this trend should continue for 2 or 3 more years. While U.S. banks haven t outperformed the overall market during this full period of superior dividend growth, they ve outperformed sectors including staples, utilities, energy and materials. From current levels, Signature believes U.S. banks should outperform the S&P 500 Index in the medium term. European and U.K. bank valuations are extremely undemanding and are likely to outperform U.S. banks from current levels. Canadian banks are likely to underperform U.S. and European banks. U.S. banks Signature has been overweight U.S. banks for quite a few years now, with the view that valuations were undemanding relative to their ability to improve capital positions and capital returns to shareholders. This positioning has generated some grey hair over the years given volatility amid JP Morgan s London whale trading scandal, negative interest rates, a collapse in energy prices, Brexit, and the ongoing Wells Fargo account fraud scandal. Our investment view has largely played out, although it took longer than initially expected back in 2010. As illustrated below in Chart 1, U.S. banks have offered strong, steady dividend growth from the 2010 trough. It s important to note that U.S. banks dividend payout ratio has fallen significantly from pre-crisis levels. We estimate the average dividend payout ratio was above 70% in 2007 and is currently running at about half of that today. U.S. banks are generally returning more capital to shareholders today via share repurchases than dividends. Sector dividends and buybacks combined are expected to be approximately $160 billion over the next 12 months. When examining 2 Queen Street East, Twentieth Floor, Toronto, Ontario M5C 3G7 I www.ci.com Head Office / Toronto 416-364-1145 1-800-268-9374 Calgary 403-205-4396 1-800-776-9027 Montreal 514-875-0090 1-800-268-1602 Vancouver 604-681-3346 1-800-665-6994 Client Services English: 1-800-563-5181 French: 1-800-668-3528
relative dividend yield as a value consideration, it is crucial that investors think about the tremendous buyback yield in U.S. banks as well. Chart 1 Source: Bloomberg, Signature Global Asset Management, as at June 30, 2018. The chart shows estimates for 2018F and 2019F; actual results may vary. As illustrated in Chart 2 below, U.S. bank dividends as a percentage of S&P 500 Index dividends haven t recovered to pre-crisis levels of roughly 17%; however, this is entirely due to the more conservative dividend payout ratio. Theoretically, at the pre-crisis dividend payout ratio of 70%, U.S. banks would be expected to generate more than 18% of S&P 500 Index constituents dividends. We find this noteworthy because the U.S. banks represent less than 7.5% of the S&P 500 Index. At a sustainable dividend payout ratio of 45%, in line with the Canadian banks, the U.S. banks would be generating almost 13% of S&P 500 Index total dividends. The gap between their dividend contribution and market weight seems too disproportionate, suggesting bank valuations remain undemanding relative to the market. We also find it noteworthy that U.S. banks have not yet made it back into some global dividend benchmarks, such as the MSCI ACWI High Dividend Yield Index. We 2
would expect U.S. banks to return to such benchmarks and dividend funds to create additional buying demand. Chart 2 Source: Signature Global Asset Management as at June 30, 2018 The chart shows estimates for 2018F and 2019F; actual results may vary. Looking forward, we would expect dividend growth from U.S. banks to remain relatively attractive but moderate from extremely strong levels. We believe U.S. bank-sector dividends in 2019 may be 20% higher than 2018 levels, which in turn are 27% above 2017 levels. This strong dividend growth has been supported by rising dividend payout ratios and strong earnings growth, which were aided by tax cuts and interest rate increases. With current sector dividend payout ratios estimated at a 35% payout ratio, the sector retains room to support dividend growth with a rising payout ratio for a few more years to perhaps 45%. In 2010, Signature took a long-term view that, as profitability and dividends normalized over time, U.S. banks would outperform the market in terms of dividend growth and price appreciation. While they have since outperformed on dividend growth, they have underperformed the broad market with regards to price appreciation. Signature anticipates 2021 U.S. bank-sector dividends being 25% higher than 2019 dividends based on increasing payout ratios, a supportive economy and moderate bank earnings growth 3
expectations. This forecast superior dividend growth relative to the market should support doubledigit price appreciation over the next year. This is above our expectations for the broad U.S. market and so we expect the long-term performance gap to narrow. As Chart 3 illustrates, the combined dividend yields and buyback yields of select U.S. financial companies are extremely supportive of potential outperformance. Chart 3 Sources: Company reports, Bloomberg as at as at June 30, 2018 For Illustrative Purposes Only. The chart shows estimates only, actual results may vary. European & U.K. banks European and U.K. banks have largely been a value trap for many years. Since June 30, 2010 European and UK banks as measured by the STOXX Europe 600 Banks Index (SX7P) have only returned 10.9% (or 1.3% per annum). Clearly, our generally steady preference for U.S. banks over European ones has worked out; however, with the KBW Nasdaq Bank Index (BKX) outperforming the SX7P so drastically, it may be 4
time to prefer European banks to their American counterparts. The SX7P ended June 2018 12% lower versus June 2017, despite modest improvements in capital and profitability. Chart 4 illustrates the valuation disconnect between European and U.S. banks as measured by the simple price-to-book ratio. While Signature believes the majority of this valuation differential is fundamentally supported, having U.S. banks trading at 170% of the European bank price-to-book ratio is excessive and, from here, European banks could start to outperform U.S. banks. Based on our individual, fundamental evaluations, we currently identify more banks in Europe, compared with the U.S., that appear more than 20% undervalued. Chart 4 Source: Bloomberg, Signature Global Asset Management as at June 30, 2018. European and U.K. bank dividend payout ratios have remained higher than in the U.S., and so their total dividends paid in U.S. dollars have consistently exceeded U.S. levels. Given the tougher economic environment, European and U.K. bank dividends are unlikely to exceed 2007 levels until 2020. Share repurchases are much less significant outside the U.S. and are only relevant in a few individual cases. The current outlook for dividend growth is promising as capital adequacy has greatly improved for the majority of financial institutions. 5
Chart 5 - Total Dividends Payout ($B) of Canadian, US and European Banks Source: Bloomberg, Signature Global Asset Management as at June 30, 2018 The chart shows estimates for 2018F and 2019F; actual results may vary. We also note that in a European market context, the banks offer relatively attractive dividend yield with superior dividend growth as illustrated below by Chart 6. 6
Chart 6 Source: Bloomberg, MSCI, Signature Global Asset Management as at June 30, 2018. For Illustrative Purposes Only. The chart shows estimates only, actual results may vary. We believe the European bank sector offers attractive and growing dividends. It s notable that the banks have very high leverage to a potential improvement in the operating environment because returns in many cases remain depressed by the low interest rate environment. Chart 7 illustrates the supportive dividend and buyback yields available. 7
Chart 7: First Asset European Bank ETF (FHB) Source: Company reports, Bloomberg as at June 30, 2018. For Illustrative Purposes Only. The chart shows estimates only, actual results may vary. Canadian banks The Canadian bank index (S&P/TSX Composite Index Banks) has returned 108% between June 30, 2010 and June 30, 2018 in U.S. currency, and 157% in domestic currency terms (largely performing in line with the U.S. s BKX Index if we ignore currency moves). Canadian bank dividends as measured in U.S. dollars have increased by 50% to US$14.4 billion in 2018 from US$9.6 billion in 2010. Note that in 2010, our domestic banks paid out 190% of what U.S. banks paid in aggregate. They currently pay out about 33% of what U.S. banks pay in total dividends. 8
Canadian banks currently have slower earnings and dividend growth than their U.S. peers; however, they continue to be excellent compounders of capital, which supports attractive dividend growth and the occasional dilutive acquisition. Stock performance over the past couple of years has lagged U.S. peers and we think that should continue. We believe late-cycle concerns are more warranted in Canada than in the U.S. and we think it is prudent to be underweight our domestic banks. First Asset ETFs managed by Signature For investors seeking direct exposure to the financial sector, Signature sub-advises two actively managed ETFs via our affiliate First Asset. These are: First Asset Global Financial Sector ETF (FSF)*; and First Asset European Bank ETF (FHB). Signature commenced managing First Asset Global Financial Sector ETF on April 18, 2016 and since then the ETF has generated a total return of 54.4% to June 29, 2018. Signature took over the management of First Asset European Bank ETF from November 22, 2016. Since then, the ETF has generated a total return of 24.2% to June 29, 2018. 9
ETF Solution 1 month YTD 1y 2y 3y Since Inception Inception Date First Asset Global Financial Sector ETF (FSF) -0.47% -2.62% 9.16% 30.06% 1.68% 3.18% 21-Nov-14 MSCI ACWI Index (Unhedged) 0.86% 4.53% 12.16% 15.43% 10.09% 11.81% 21-Nov-14 MSCI ACWI Financials Index (Unhedged) (TR) -0.95% -1.60% 6.55% 19.57% 8.77% 11.10% 21-Nov-14 First Asset European Bank ETF (FHB) 1.28% -4.46% -1.38% 23.76% -4.35% -1.99% 23-Jul-14 STOXX Europe 600 Banks Index -0.59% -12.39% -11.57% 13.34% -8.78% -4.38% 23-Jul-14 MSCI Europe Banks Index (CAD Hedged) -0.59% -8.95% -7.49% 20.52% -1.12% 1.34% 23-Jul-14 MSCI Europe Index (CAD Hedged) -0.29% -0.45% 4.30% 11.98% 5.69% 6.10% 23-Jul-14 Source: Morningstar and First Asset as at June 30, 2018. *FSF was originally launched as a TSX-listed closed-end fund on November 21, 2014, and converted into an exchange traded fund on April 25, 2016. Performance shown is since inception of the closed-end fund. In connection with the conversion, and pursuant to unitholder approval, the annual management fee payable by the Fund to First Asset, as manager, was reduced to 0.85% (from 1.00%) of the NAV per unit and certain changes were made to the investment objectives, strategies and restrictions applicable to the Fund. Material among these changes is the ability of the Fund to invest in securities of global financial issuers; thereby broadening the scope of eligible investments both geographically and by type of financial institutions. On April 18, 2016, Signature Global Asset Management, a division of CI Investments Inc., commenced investment advisory and portfolio management services for the Fund. Had these changes been in effect prior to this date the performance of the Fund could have been different. The MSCI ACWI Index captures large and mid-cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. With 2,490 constituents, the index covers approximately 85% of the global investable equity opportunity set. This index is used as a benchmark to help you understand the Fund s performance relative to the general performance of global developed and emerging markets. The MSCI ACWI Financials Index captures large and mid-cap representation across 23 Developed Markets and 23 Emerging Markets countries. All securities in the index are classified in the Financials sector as per the Global Industry Classification Standard (GICS ;). This index is used as a benchmark to help you understand the Fund s performance relative to the general performance of the financial sector within global developed and emerging markets.. 10
The STOXX Europe 600 Banks Index is a capitalization-weighted index which includes the largest and most liquid 600 European companies that are involved in the bank sector. This index is used as a benchmark to help you understand the Fund s performance relative to the general performance of European banks. The MSCI Europe Banks Index is composed of large and mid-cap stocks across 15 Developed Markets countries in Europe. All securities in this index are classified in the Banks industry group (within the Financials sector) according to the Global Industry Classification Standard (GICS ). This Index is used as a benchmark to help you understand the Fund's performance relative to the general performance of European banks.. The MSCI Europe Index captures large and mid-cap equities across 15 Developed Markets countries in Europe, covering approximately 85% of the free float-adjusted market capitalization with that universe. This Index is used as a benchmark to help you understand the Fund's performance relative to the general performance of the broader European equity markets. Further information about these ETFs, including the prospectus and ETF Facts sheet, can be found at www.firstasset.com or www.sedar.com. Signature funds Signature s investment view with regards to the global financials sector has supported outperformance of financial holdings in our Signature Global Equity and Signature Global Dividend mandates in each of the past six calendar years. Table 1: Signature fund performance versus benchmark Signature Fund YTD 1y 3y 5y 10y Since Inception Inception Date of Fund Signature Global Dividend Fund 0.41 6.86 6.94 11.7 N/A 12.83 12/20/2012 MSCI ACWI High Dividend Yield Total Return Index** 1.83 6.9 9.03 12.25 8.84 13.48 N/A Signature Global Equity Fund 4.69 14.83 9.34 12.72 7.2 2.47 8/8/2000 MSCI All Country World Total Return Index# 4.85 12.75 10.69 14.96 9.17 4.49 N/A Source: Morningstar and CI Investments as at June 30, 2018. NB. Benchmark returns cited within Table 1 reflect the fund s inception date. Table 1 above shows Signature Global Dividend Fund s and Signature Global Equity Fund s annual compound returns for each year indicated, compared with the MSCI ACWI Global High Dividend Yield Total Return Index and MSCI All Country World Total Return Index, respectively. 11
**The MSCI ACWI Global High Dividend Yield Total Return Index is a float-adjusted market capitalization weighted index based on MSCI ACWI Index. The Index is designed to reflect the performance of equities in the parent index with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. #The MSCI All Country World Total Return Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Index consists of 46 country indices comprising 23 developed and 23 emerging market. The developed market country indices included are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States of America. The emerging market country indices included are: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment, tax, legal or accounting advice or an offer or solicitation to buy or sell securities, and should not be relied upon in that regard. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Commissions, trailing commissions, management fees and expenses all may be associated with investments in mutual funds and exchange traded funds (ETFs). Please read the prospectus before investing. Mutual funds and ETFs are not guaranteed, their values change frequently and past performance may not be repeated. The indicated rates of return are the historical annual compounded total returns including changes in security value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. The opinions contained in this communication are solely those of the Portfolio Manager, Signature Asset Management, at the indicated date of the information and are subject to change without notice. Certain statements in this document are forward-looking. Forward-looking statements ( FLS ) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as may, will, should, could, expect, anticipate, intend, plan, believe, or estimate, or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not 12
guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Investments Inc. and the Portfolio Manager believe to be reasonable assumptions, neither CI Investments Inc. nor the Portfolio Manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise. This communication includes information that has been obtained from third party sources. Although the Portfolio Manager believes that these independent sources are generally reliable, the accuracy and completeness of such information is not guaranteed and has not been independently verified. The Portfolio Manager and CI Investments assume no responsibility for any losses or damages, whether direct or indirect, which arise from the use of this information and expressly disclaims liability for any errors or omissions in this information. First Asset ETFs are managed by First Asset Investment Management Inc. ( First Asset ), a wholly owned subsidiary of CI Financial Corp. which is listed on the Toronto Stock Exchange under the symbol CIX. CI Financial is a registered trademark of CI Investment Inc., used under license. CI Investments, the CI Investments design, and Signature Global Asset Management are trademarks of CI Investments Inc. Signature Global Asset Management is a division of CI Investments Inc., which is a wholly owned subsidiary of CI Financial Corp., and each are affiliates of First Asset. 13