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Omissions, CBA & Magellan

Omissions generally are not accidents. The world turns collectively on our every action and our every omission whether we know it or not.

Omissions, either by CBA management and or the board, will be a central theme in the AUSTRAC money laundering case. APRA and ASIC are circling the bank as well. A corporate mugging in the making by the regulators. CBA’s price has dropped 10% in the past six months. And I think it has more to fall – possibly into the low $60’s.

Three reasons why.

1) Reputational Risk. Australian banks rely on overseas funding for their mortgage books – their principal revenue earner. CBA will pay more for capital if it’s A grade credit rating it affected. That flows through to net interest margin, impacting profitability and potentially dividends. CBA already looks expensive – on a price to book ratio of almost 2 times, and recent regulatory changes have boxed in revenue growth of the Australian banks, according to Citibank. Hedge Funds already are short the stock – about 1.5% of the bank’s capital. Any negative talk about earnings will see this short position grow aggressively. Particularly if safe haven investors like super funds switch from CBA to its peers or other sectors. There are no bargains in the local banks.

2) Fines. CBA is facing 52,000 offences, of which it appears a handful will become the court ping pong with the regulator. Overseas regulators have walloped banks stepping out of line with huge fines running into the hundreds, if not billions of dollars. CBA will not get off with the slap of a wet lettuce leaf. Our regulators are mindful of their international reputation. CBA’s fine notice will need more space for the extra zeros it will need to fill in. CBA’s mea culpa may be to pay a big enough fine to stay proceedings. And that fine comes out of the pot making up shareholders dividends.

3) Class Action. A mugging by the three preeminent regulators will lead to a lawyer fest of class action against the CBA board. Long and expensive. And it is a fair bet that while insurers may pick up some of the tab, shareholders dividends will in the firing line for the rest.

Australian banks are a significant percentage of the Australian market and with them now facing crimped revenue growth we think the opportunity is to switch from CBA to a more international focus.

Why? Because international equities offer Australian investors the ability to access a broader opportunity set, with the potential to invest in sectors not represented or not well represented in the Australian market. Given international markets are not perfectly correlated with the Australian market, they also afford portfolio diversification benefits. The Australian market represents about 2% of the global market.

Chris and I have are looking at the new listed Magellan Global Fund. We think this is worth backing. The Fund is looking to raise around $1 billion at $1.50 a share. The best bit from an investor’s view is the listed investment trust is paying its own ASX listing and distribution fees. Which means the units will trade at full face value. And not at a discount, which most listed investment companies do. The difference is unitholders don’t spend the first year chasing performance just to get square.

No absolute internal return is quoted, but it’s worth noting similar Magellan strategies target absolute returns of 9% to 10% p.a. net of fees over a business cycle (five to seven years). The Trust’s investment strategy is to actively manage a high conviction portfolio of global securities, actively manage currency hedging. It also has relatively few formal investment parameters and is a benchmark unaware investment vehicle. The Trust will typically hold between 15 to 30 securities and can invest up 50% of the portfolio in cash (currency denomination at the portfolio manager’s discretion) as a capital preservation / risk control mechanism. The Trust is also able to borrow up to 20% of the Trust’s gross assets.

Kimber Capital has reserved an allocation in the Magellan Fund.  So it’s a case of first in.  Don’t omit to do, commit to selling CBA and buying Magellan!

Kim Slater

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