• Vector Insights

    Playing opposing views on the Banking Royal Commission

    Russel Chesler, Director, Investments & Portfolio Strategy
    06 April 2018
     

    The Australian banking system is said to stand on Four Pillars, meaning the big four banks: ANZ, CBA, NAB, WBC. The four pillars represent over 25% of the S&P/ASX 200 Accumulation Index by market capitalisation, providing products and services that are essential to the economy.  

    Australian banks are now facing their fourth inquisition in four decades. The Royal Commission closely follows the Financial System Inquiry which was chaired by ex-Commonwealth Bank chief David Murray whose report was handed down in 2014. That report resulted in banks increasing risk weighted assets to offset mortgage risks, stronger superannuation by expanding choice and stronger regulation of financial advice. The Murray Inquiry was the third inquiry into banking and followed the 1996 Wallis Inquiry and the original 1979 Campbell Inquiry.

    The Campbell Inquiry was a turning point in Australian economic history. Apart from being the first inquiry in the financial system, it was the start of the rise of the banking sector. At the time they were sleepy businesses. One of the biggest ones was Government owned; the Commonwealth Bank.

    The Campbell Inquiry led to the floating of the Australian dollar and much freer movement of money across our border. It also led to foreign banks being able to open their doors in Australia. This was needed at the time to lift the sophistication of the sector. Australian banks responded. They began their evolution into the giants of the Australian economy they are today.

    By 1997 the financial services sector had completely changed. The banks were now so large and powerful that they needed greater supervision. In response, the Federal Government established the Wallis Inquiry, which resulted in a more powerful regulatory framework. Two regulators were established: the Australian Prudential Regulation Authority (APRA), responsible for prudential regulation; and the Australian Securities and Investments Commission (ASIC), responsible for market integrity, financial products and consumer protection.

    However, various exposés of sales-driven cultures, banks misleading consumers, scandals concerning rigging of benchmark interest rates, money laundering and poor financial advice practices all resulted in political pressure for a Royal Commission, to which Prime Minister Malcolm Turnbull eventually succumbed last year.

    Headwinds strengthen

    Pessimists view the Hayne Royal Commission as a headwind for banks. The regulatory environment since the Campbell Inquiry has been conducive for growth, even after the Wallis Inquiry. Further regulations, pessimists say, are the biggest headwind that could come out of the Royal Commission and inhibit future growth. The focus on risk management will force banks to incur additional costs, on top of increased capital requirements enforced on banks as a result of the GFC. Furthermore, pessimists see the likelihood of increased competition in the sector.

    Are banks oversold?

    Optimists, on the other hand, see the four major banks as wielding immense power due to their size, their essential role in modern society, their diversification and their oligopoly power. Banks have emerged from past scrutiny, stronger than ever. They continue to make record profits, despite low earnings growth. These are very big businesses and if they need to spend money on new initiatives either internally or through acquisitions, they can certainly afford to.

    Bank shares may be down, but it is arguable they have been oversold. Despite the headwinds, Australia’s largest four banks operate as an oligopoly that gives them a structural competitive advantage, ensuring they’ll deliver excess profits over the long-run. They also continue to offer fully franked dividend income that looks more attractive relative to bonds and the broader market which is likely to drive continued demand for bank shares. Also, when interest rates start to rise, banks stand to benefit. Unlike bond values, their share prices may well rise on higher interest rates as their margins will likely improve, the optimists say.

    Position your portfolio

    Whether you are an optimist or a pessimist, some degree of exposure to the Australian banking sector is important for a well-balanced portfolio.

    ETFs are trading tools that allow investors to express their view and build an investment portfolio via a single trade on ASX. VanEck offers three ETFs which enable you to achieve varying degrees of exposure to the Australian banking sector depending on your confidence level:

    • Low confidence: You can achieve low exposure to the banks while maintaining broad diversified exposure to the rest of the Australian economy using VanEck Vectors Australian Equal Weight ETF (MVW);
    • Moderate confidence: You can achieve a moderate exposure to the banks in a diversified portfolio of companies that pay dividends with 100% franking credits using VanEck Vectors S&P/ASX Franked Dividend ETF (FDIV); or
    • High confidence: You can access pure banks exposure using VanEck Vectors Australian Banks ETF (MVB).

    The following chart details the varying levels of exposure to Australian banks offered by VanEck’s ETF strategies.

    Level of confidence

     

    Bank exposure

    Strategy

    ASX code

    No. of holdings

    Summary

    Low

     

    9%

    VanEck Vectors Australian Equal Weight ETF

    MVW

    84

    • Invests equally in the largest and most liquid ASX-listed companies across all sectors.
    • Companies are weighted equally in the fund every quarter.
    • True diversification across securities and market sectors reducing concentration risk.
    • Offers greater potential growth opportunities via higher exposure away from the mega caps like the big four banks that dominate typical Australian equity portfolios.

    Moderate

     

    35%

    VanEck Vectors S&P/ASX
    Franked Dividend ETF

    FDIV

    28

    • Invests in companies within the S&P/ASX 200 that have paid out 100% franked dividends in the past two years.

    High

     

    100%

    VanEck Vectors Australian Banks ETF

    MVB

    7

    • Invests in Australia's largest and most liquid ASX listed banks.
    • Does not include non-bank financial institutions such as asset managers and insurance companies.
    • Delivers the growth and yield of the banks by passing on all dividends (less management costs) and franking credits.
    • Exposure to individual banks capped at 20%.
    • The only fund of its kind in Australia.

     

    These three options give investors considerable flexibility. In addition to their ease of trading on ASX with live prices throughout the day, VanEck’s ETFs give investors full transparency to their underlying holdings, including bank shares, on a daily basis, unlike managed funds or active ETFs. ETFs offer better liquidity than unlisted managed funds and similar liquidity to holding bank shares directly. So no matter your outlook on banks, VanEck’s ETFs allow you to invest according to your conviction.

     

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