Author: Andy Schornack
Covestor model: Financial Services
Disclosure: Long KKR, MS
The performance for the portfolio during the month of November was somewhat disappointing, as it underperformed both the SPSY (S&P Financials Index) and the S&P 500 Index.
The financial sector continues to be a contrarian investment across the investment universe. I personally find the fear of Europe contagion risk equal to the fear of wide nationalization of the banking industry in the United States in February and March 2009. Call me an optimist, but I don’t see Europe allowing such a drastic and negative situation to manifest itself to large scale contagion. The central banks have already announced a widescale and coordinated liquidity plan, yet the market has more or less placed its odds on the ultimate failure of Europe to come to consensus on a navigable plan on repositioning the sovereign leverage within the Euro Zone and thereby reduce the risk to its financial institutions and the Euro.
In times like these you review the portfolio’s positions regularly to make sure that the investment thesis still holds true. Over the past month, I have made only one change – the sale of the position in Medallion Financial (TAXI). The investment thesis had run its course, given the recent run up over the past 90 days. I waited to sell only after the ex-dividend date to collect one last dividend at $0.19/share.
One of the most volatile stocks in the portfolio is currently Morgan Stanley (MS). My thesis continues to remain true, and I plan to continue to hold this position in the portfolio. The bank reported a tangible book value per share of $27.79 and bank capital of $61.8 billion. Furthermore, it reported its net funded exposure $2.1 billion to the PIIGS and Negative $286 million to France. This in and of itself does not make MS a great investment opportunity and without risk. There is risk in everything, but it is my opinion that the market is undervaluing the risk control and repositioning the management has implemented since 2008. Furthermore, Morgan Stanley will continue to be a major global wealth manager and leading investment bank. The stability of the wealth management business will help stabilize the volatility of the investment banking/sales and trading activities.
A position I have not discussed in much detail over the past several months, which I recently added to, is KKR & Co, LP (KKR). KKR is mostly known as a private equity firm, but it also has a growing asset management business. The position was initially added in July 2010 and was increased in November 2011.
My original thesis for KKR continues to ring true:
(1) Businesses continue to build significant cash reserves and reduce leverage on their balance sheet, making them a prime target for a PE firm.
(2) Multiples and competition on business acquisitions have been reduced.
(3) KKR is and will continue to be a brand name in the private equity business.
(4) KKR has the ability to purchase discounted enterprises and the management wherewithal to grow and capitalize on them for its shareholders as has been shown over years of transactions.
The fee based business provides more stability than the market gives its credit for and this provides opportunity for the investor. The stock continues to trade at a discount to the sum of its parts and provides for a healthy dividend yield.
This portfolio is structured to provide dividend income with a target minimum yield of 3%. This provides a stable return of capital during the market volatility that can be redeployed into new opportunities or to add to existing positions.
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