Trumponomics: What tariffs could mean for small caps

abrdn

March 2025

Funds operated by this manager:

abrdn Sustainable Asian Opportunities Fund, abrdn Emerging Opportunities Fund, abrdn Global Corporate Bond Fund (Class A), abrdn International Equity Fund, abrdn Multi-Asset Income Fund, abrdn Multi-Asset Real Return Fund, abrdn Sustainable International Equities Fund

Making sense of the banking sector

Airlie Funds Management

March 2025

How long will the extraordinary rally continue?

The banking sector enjoyed an extraordinary rally in 2024, with the Big Four Banks delivering an average TSR of 33%. As recently as February, Commonwealth Bank (CBA), for instance, enjoyed a price to earnings multiple of 26x- a 60% premium to its historical average. This raises an important question: are these valuations justified for a sector that has not grown its overall earnings per share over the last 10 years?

To look at this in another way, you can see in the chart below that the collective earnings of the Big Four are only today back to where they were in 2018. Yet if we add up the cumulative share prices of the banks, you're paying $233 in total for all four banks versus $157 in 2018 for the same level of earnings. And this is after the recent share price rout; at the banks' peak in February, you would have paid a cumulative $276 for these earnings.

Are banks really making more money? The net interest margin story

At its core, banking profitability hinges largely on a single key metric: Net Interest Margin (NIM). This is the difference between what a bank earns on loans and what it pays on deposits. The higher the margin, the more profitable the bank.

However, over the past few decades, this margin has been steadily shrinking. This decline has been driven by three key structural changes in the industry:

1. Mortgage brokers

Over the past decade, the share of mortgage broker-originated loans has surged from ~50% to 75%, significantly squeezing bank margins. Banks pay the broker a large upfront commission of ~0.65% of the loan value ($6.5k for every $1m lent) and a trailing commission of 0.15% per year. Moreover, because brokers focus on securing the lowest possible rate for customers, mortgages have become increasingly price-driven, reducing banks' ability to charge more favourable rates. Since brokers earn their largest commission when writing a new loan, they have an incentive to refinance customers regularly, which further erodes bank margins. The Commonwealth Bank estimates that the broker channel is 20-30% less profitable than a loan originated through a bank's proprietary channel. 

2. Entrance of Macquarie

Over the last decade, Macquarie Group has entered the banking sector, employing a digital, broker-led model where it can operate a lean model without the tech debt and branch costs of its traditional competitors. The company has successfully grown its share to ~5% and its ease of use has made it popular with brokers. Unlike the major banks, Macquarie doesn't need to maintain a constant presence in the mortgage market. It has entered when risk and pricing are attractive and exited when margins tighten, making it a highly agile competitor. This dynamic prevents periods of excess profitability for the Big Four, as Macquarie re-enters the market whenever rates become too favourable for banks.

3. Exit from broader business lines

In the past, banks operated in higher-margin businesses such as wealth management and insurance. While these divisions may have distracted them from mortgage competition, they also provided additional profitability. With banks now exiting these areas, mortgage lending has become their primary battleground, intensifying competition and further pressuring margins.

Bad debts are low but can this last?

One of the biggest risks for any bank is loan defaults, which result in bad debt expenses; that is, the losses banks take when borrowers can't repay their loans. Historically, Australian banks have averaged bad debt expenses of ~0.15% to 0.20% of gross loans and acceptances.

In FY24, this figure was just 0.08% - about half the long-term average. While this looks like a positive for bank earnings, the key question is: is this sustainable?

Why are bad debts so low right now?

There are three key reasons bad debt expenses remain unusually low:

1. Favourable economic conditions. Strong employment and rising house prices mean most borrowers can still meet their repayments. Even if someone loses their job, they can often sell their home at a premium, allowing the bank to recover the loan without taking a loss.
2. Covid-era provisions act as a buffer. During the pandemic, banks set aside large provisions for expected loan losses that never fully materialised. These reserves have been gradually released, reducing reported bad debt expenses in recent years.
3. Shift towards lower-risk lending. Some argue that historical bad debt levels aren't as relevant today because banks now focus more on residential mortgages rather than riskier business lending, which traditionally had higher default rates.

The real risk: Are banks underestimating future loan losses?

While bad debts are currently low, history suggests this won't last forever. Since current bank earnings are inflated by unusually low bad debt expenses, it's reasonable to assume:

• Future earnings may be overstated at today's valuations.
• A normalisation of bad debts could reduce bank profitability more than expected.

Bottom line? The current low levels of bad debts make bank earnings look better than they likely are in the long run, suggesting investors should be cautious about assuming today's profits are sustainable. To pick on ANZ as an example - and we chose ANZ because it has the lowest level of provisioning for bad debts - if the bad debts expense were to normalise to ~0.20% of gross loans and acceptances (the pre-covid FY16-19 average) from 0.05% in FY24, its EPS would have been ~13% lower.
 

Expenses

One area where banks could justify a higher valuation is through improved efficiency. However, the track record here is mixed. While banks have closed physical branches and pushed digital banking, these savings have been offset by rising IT spending, cybersecurity costs and regulatory compliance. Additionally, employee expenses account for ~70% of a bank's cost base and wage pressures remain high. The net result? Banking cost bases have proven resilient, making it difficult for them to structurally improve profitability through expense reduction.

Since FY16, bank expenses have grown at ~1.7% p.a. compared to income growth of just 0.9% p.a.
 

This means that despite cost-cutting efforts, banks struggle to convert these savings into higher profits because any efficiency gains are competed away in lower prices for customers. As a result, cost-cutting alone is unlikely to drive meaningful margin expansion at the sector level.

Over time cost efficiencies (lower cost-to-income (CTI) ratio) have been reinvested back in the customer
 

Source: JP Morgan

Are bank valuations justified?

The 2024 banking rally may suggest a thriving sector but the fundamentals tell a different story:

• Net interest margins remain under pressure as mortgage brokers dominate the market and Macquarie intensifies competition.
• Bad debt expenses are at historic lows but history suggests they will normalise over time, reducing earnings.
• Cost-cutting has failed to translate into sustained profitability, with banks reinvesting savings into lower prices to stay competitive.
• Volume growth will remain moderate, given Australia has one of the highest household debt-to-GDP ratios globally.

Given these challenges, the current high bank valuations appear disconnected from long-term earnings potential.

By Jack McNally, Investment Analyst

Funds operated by this manager:

Airlie Australian Share Fund, Airlie Small Companies Fund

Important Information: 

This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation.  This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. No representation or warranty is made with respect to the accuracy or completeness of any of the information contained in this material. Airlie will not be responsible or liable for any losses arising from your use or reliance upon any part of the information contained in this material.

Any third party trademarks contained herein are the property of their respective owners and Airlie claims no ownership in, nor any affiliation with, such trademarks.   Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks.  This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Airlie.

New Funds on FundMonitors.com

Below are some of the funds we've recently added to our database. Follow the links to view each fund's profile, where you'll have access to their offer documents, monthly reports, historical returns, performance analytics, rankings, research, platform availability, and news & insights. 

Want to see more funds?

Subscribe for full access to these funds and over 900 others

Chris Gosselin, CEO of FundMonitors.com, speaks with Benjamin Harrison, Chief Investment Officer at Altor Capital. 

Ben discussed the growing investment opportunities within the global sports industry, highlighting its diverse revenue streams and Altor's strategic focus on both team ownership and related support sectors. The conversation underscored the potential for meaningful investor involvement beyond just elite-level teams, particularly within Australia's mid-market sports landscape.

Funds operated by this manager: Altor AltFi Income Fund, Altor Emerging Growth Fund

Hedge Clippings | 28 March 2025

All of a sudden, the phoney war is over and the real campaign has begun. Tuesday night's 2025-26 Federal Budget has been handed down, and as expected it turned into a classic pre-election cash splash. Prime Minister Anthony Albanese then made the trip to Government House first thing this morning to call the federal election for 3 May - a five-week sprint to polling day, punctuated by the Easter and Anzac Day break.

While Treasurer Jim Chalmers insists his budget is about "building a better future," it's widely seen as a blatant vote-buying exercise, stuffed to the gills with cost-of-living sweeteners. After running two rare budget surpluses, Chalmers has now opened the purse strings: the deficit is expected to hit $27.6 billion this year and $42.1 billion next year. Fiscal purists may wince, but most punters will shrug - those are just mind-boggling numbers on paper, far removed from the average voter's hip pocket. And hip pockets, of course, are exactly where this budget aimed.

Sure enough, Tuesday's budget rolled out a Santa's sack of energy rebates, rent assistance, cheaper GP visits and PBS medicines. In other words, the usual household budget pleasers. A last-minute surprise - $17 billion in income tax cuts - gave Labor a rare chance to campaign on tax relief and left the Coalition looking awkwardly flat-footed.

Cue Peter Dutton's budget reply, which promised to outbid Labor with a halving of the fuel excise and a vow to repeal those very tax cuts. A strange role reversal for the Liberal Party, but we are in pre-election auction season, where handouts come first and policy coherence later - if ever. Talk of real reform (say, fixing the tax system) didn't even get a look in.

Meanwhile, speculation is growing that Albanese may not remain Labor leader for long. Dutton didn't miss the chance to stir the pot, suggesting Jim Chalmers is circling. The Treasurer, who's been on a media blitz since Budget night, certainly isn't shying away from the spotlight. Whether he's positioning himself for a leadership change or just basking in the glow of a very political budget, the message is clear: he's ready, just in case.

Markets, for their part, aren't overly fussed. Pre-election budgets tend to play well with voters but don't rattle investors - especially when both sides are throwing money around and avoiding anything too radical. Inflation could get a nudge, but the RBA likely stays on the sidelines for now. In short: more of the same.

If all of this seems a bit familiar, that's because it is. Still, there's comfort in a local political drama that, for once, isn't dominated by overseas chaos. Enjoy it while it lasts - not only because next Tuesday is April Fools Day, but because Donald Trump is due to announce his next round of tariffs.

News & Insights

Manager Insights | Altor Capital on the Business of Sport

The future of healthcare: Trump, policy and innovation | Magellan Asset Management

Market Commentary | Glenmore Asset Management

February 2025 Performance News

Equitable Investors Dragonfly Fund

DS Capital Growth Fund

Insync Global Quality Equity Fund

Insync Global Capital Aware Fund

DAFM Digital Income Fund (Digital Income Class)

TAMIM Fund: Global High Conviction Unit Class

ASCF High Yield Fund

If you'd like to receive Hedge Clippings direct to your inbox each Friday

JOIN OUR MAILING LIST

DeepSeek is much more than the Sputnik Moment

Ox Capital (Fidante Partners)

February 2025

The introduction of DeepSeek into the market exemplifies the technological advancements that Chinese companies have achieved in recent years. Through company visits and discussions with local experts, we are seeing significant technological advancements in China. These developments are partly driven by necessity, in response to increasing restrictions from its global competitor, the United States.

In addition to DeepSeek, platforms like TikTok and Temu have grown on Western consumers. They are leapfrogging the traditional internet platforms and driving convergence in social and e-commerce. Beyond these visible changes, there are numerous technological advancements that may not be immediately apparent to consumers. These include developments in robotics, electric vehicles, batteries, renewable energy such as solar and wind, and nuclear energy.
The advancements have been made possible through rapid iterations of product designs, driven by intense competition. Notably, these waves of innovation and cost reduction are not the results of top-down directives but rather classic Darwinian competition. Weaker domestic players have been eliminated, allowing stronger players to survive and evolve into globally successful companies.

The large domestic market, availability of low-cost and skilled engineers, access to capital, and affordable infrastructure have contributed to China's significant share in global manufacturing. China accounts for about ~33% of global manufacturing capacity, exceeding that of G7 countries combined. This percentage is expected to grow as Chinese companies make progress in new (and higher value) industries. Consequently, the economy can produce a wide range of products at very low cost at scale, except for high-end semiconductors (at present).

With its huge, educated work force, ample spare capacity, and large domestic market, entrepreneurs are afforded a runway to build great businesses. For instance, a hedge fund manager has managed to innovate and develop DeepSeek, a cost-effective AI solution. Similarly, several Chinese companies are poised to become significant players in robotics and are likely to be major suppliers of robotics components globally. Robotics may be the next high tech success story in China, following the footsteps of the domestic EV makers.

The challenging transition in China was due to a realization by domestic authorities that the ever-expanding construction sector would eventually lead to negative consequences for the economy. Therefore, a shift towards quality and sophisticated products was deemed necessary. This transition is nearly complete, and the benefits of these efforts are expected to emerge as these new growth sectors begin to offset the decline in traditional industries such as property construction, which has experienced a significant reduction of approximately 70% from its peak.

The re-orientation towards quality has resulted in local players gaining market share in almost all industrial and technological sectors domestically. This trend may extend to the rest of the world, depending on trade dynamics in the coming years. The cost and quality advantages of Chinese cars, batteries, robots, and AI are expected to be highly appealing globally. While some countries may choose to block BYD or DeepSeek, they will be stuck with gas guzzlers and expensive AI models while the rest of the world get to benefit from having stronger ties with China and its companies!

At Ox Capital, we own a number of innovative businesses in China that we believe will become global champions. We firmly believe we own companies that are going to disrupt industries rather than those that will be disrupted. Given the negativity that is still prevalent on Chinese (particularly in Hong Kong) shares, the plethora of opportunities is too good to ignore!
Important Information

Funds operated by this manager:

Ox Capital Dynamic Emerging Markets Fund

Important Information: This material has been prepared by Ox Capital Management Pty Ltd (Ox Cap) (ABN 60 648 887 914) Ox Cap is the holder of an Australian financial services license AFSL 533828 and is regulated under the laws of Australia. This document does not relate to any financial or investment product or service and does not constitute or form part of any offer to sell, or any solicitation of any offer to subscribe or interests and the information provided is intended to be general in nature only. This should not form the basis of, or be relied upon for the purpose of, any investment decision. This document is not available to retail investors as defined under local laws. This document has been prepared without taking into account any person's objectives, financial situation or needs. Any person receiving the information in this document should consider the appropriaten

Tim Hext: Three key takeaways from Australia's

latest national accounts data

Pendal

March 2025

IT'S been five years this week since the Covid chaos emerged.

Aftershocks have kept rolling in since then. But is the Australian economy finally starting to look more "normal"?

The latest set of Australian national accounts (see below) shows Gross Domestic Product growth at 0.6% for the December quarter, suggesting that conditions may, indeed, be moving closer to normal.

Why is that? Below are three takeaways from the latest data. 

1. The consumer is back, but still cautious

The consumer is finally emerging, albeit tentatively, as a positive impact on the economy.

Household consumption grew by 0.4%, contributing 0.2% to the 0.6% overall GDP growth. The contribution had been near zero over the previous year.

Consumers finally had positive real wages growth in 2024 (3.2% wage growth versus 2.5% inflation).

Consumers also spent some of the Stage 3 tax cuts since July. We estimate that around 25% was spent and 75% saved, helping the savings rate to climb to 3.8% from below 3% a year ago.

2. Governments are still a large driver of GDP. Will they pull back further to make room for the consumer?

Government consumption grew by 0.7% in Q4, driven largely by the states. This is at least moderating from near 1.5% growth a quarter earlier.

Government investment also moderated but remains high at 1.8% over the quarter. Overall, the public sector contributed 0.2% to the 0.6% growth.

The government needs to keep moderating spending and investment if the re-emerging consumer is to avoid causing inflationary pressures.

In many areas of the economy, the private and public sectors compete for supply of labour, capital and goods.

3. Private investment remains weak, adding to poor productivity

Private investment rose only by 0.3% in the quarter. Business investment is showing some signs of life, but dwelling investment is falling -- not helped by high rates.

There are, as always, different stories in different sectors. But the overall picture is productivity continuing to flat-line.

GDP per hour worked fell again and is 1.2% lower over the year.

The focus on Australia's poor productivity is becoming a bigger issue.

Everyone has their reasons for it and different lobby groups will shift blame, promoting their own solutions (which normally involve government hand-outs).

However, I did come across the graph below courtesy of Minack Advisors. 

 Put simply, as our capital-to-labour ratio has fallen, so has labour productivity.

Net investment to GDP is around the lows of the past 50 years against labour force growth at the highs (courtesy of immigration and participation).

Overall, the latest today's national accounts report offers some hope of GDP moving back to the 2% to 2.5% the RBA is looking for.

However, unless we can start improving productivity, we will be running to stand still.

Author: Tim Hext

Funds operated by this manager:

 This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com