GOING TO DELPHI: Financial Sector

The U.S. markets finally fell in 2009, but in the context of the last few months it was just a run-of-the-mill bad day: S&P 500 was down 3%.  If you’re with me and sense that this rally has legs, I want to sift through the wreckage of the financials sector that probably suffered most from indiscriminant selling.  Specifically I would want to build exposure in no-brainer intermediate-term trends like mutual funds companies capable of delivering institutional services, the accelerated rise of the independent advisor, and boutique investment banks.

Between charlatan extraordinaire Bernie Madoff, train menace Adolf Merckle (the German Warren Buffett we’re told), and the Satyam (accounting scandal (India's Enron), it is a minor miracle there hasn’t been a popular backlash of some sort.  My theory is that schadenfreude is playing a large role as for the first time in recent memory the richest (and aspirational) have been disproportionately affected.  When the zeitgeist is to help everyone but, hedge fund victims are probably deemed acceptable collateral damage.  After all, although the wealthy are much less experienced in handling humiliation, frustration or distress, but are hardly helpless.

To clarify, I am not advocating a net-long position within financials as a goal, but I think it’s still too early to short the investment banks-cum-bank holding companies, credit cards, and REITs, especially chasing a big down day.  Also, during the upcoming earnings season, it will still be premature to be able to challenge management’s veracity when everybody is going more or less get away with a) pleading ignorance about when to forecast a market bottom; b) confident in its ability to execute the business model [although conditions have changed dramatically]; c) is cautiously optimistic; and d) recently favored with a government-sponsored backstop. 

Market Share Winners are Better Than Nothing.  People still need to reach retirement, but today’s priorities are liquidity and transparency over the opaque hedge fund structure.  No matter how much value they typically add, the arbitrary gate policy could not have been exercised at a worst time.  Even though the limited partners should have better scrutinized the contracts they signed before handing off the money, LT legacy was sacrificed for ST expediency by the fund operators.  That's expected, though.  However, many fund-of-fund (FoF) managers were apparently collecting override fees for not doing what they were paid to do: conduct manager due diligence and provide strategy diversification.   Whoopsie.  Some long ideas:

Mutual Funds.  In the aftermath, why can’t the bigger and better managed mutual fund complex fill this void?  They already have pseudo FoFs with the popular target date funds. Bulking up their long/short offerings and adding market-neutral strategies should be easy as would be adding hedge fund refugees on the cheap.  Talent probably would even consider relocating outside the Greenwich-Wall St. corridor to places like Valley Forge, PA (Vanguard) or Baltimore, MD (TROW, LM, setting of HBO's The Wire)! 

Independent Advisors.  Since people have neither time, capability, or inclination to manage personal wealth the role of the financial advisor has only strengthened now that the robustness of the buy-and-hold myth has been sufficiently debunked.  Recently the only things keeping advisors or brokers from fleeing in droves from the brand name wire-houses were golden handcuffs and the benefit of prestige.  Both have been rendered moot now and a well run independent asset manager with an appetite for entrepreneurship (and fatter profits) will put out there own shingle.   Charles Schwab (SCHW) has a rapidly growing business servicing this precise cohort. 

Boutique Investment Banks.  How the mighty have fallen.  In a market where the only M&A partners seem to be cash-rich strategic buyers, the league tables are going to be turned-upside down.  Literally.  I suspect an old brand name like Lazard (LAZ), which also has a well-established asset management business, is capable of returning to its prior eminence and newer upstarts like Greenhill (GHL) and Evercore Partners (EVR) can grow beyond their niche.  I’m less sanguine on the public private equity or hedge funds for obvious reasons, but the consensus view of inevitable industry consolidation keeps me cautious right now until we see more developments at BX, OGM, FIG or GLGs of the world.

Lender Processing Services.  LPS was spun-off from Fidelity National Financial (FNF) last July, and is theleading provider of integrated technology and services to the mortgage industry. Its default services business within its Loan Transaction Services segment is grew 97% y/y in the 3Q and is as anti-cyclical as you can get.

Net 1 UEPS Technologies.  If you're looking for a spec long I suggest a look at UEPS. The company provides universal electronic payment systems using a proprietary smart card/reader platform.  The target market is provide an alternative payment system for the unbanked and under-banked populations in South Africa and other frontier markets.  Fast growing with plenty of cash, and no liquidity issues.

Disclosures: No position.