In recent times the market has experienced significant volatility. Contagion appears to have gripped the broader market, with falls in commodity prices spreading to drag the other sectors sharply lower. Inherently, simultaneous falls in the prices of Iron ore, oil, coal and gold places significant downward pressure on the ASX given to the overwhelming index weighting towards the mining sector.
Perhaps now more than in past decades investors need to be very cautious when selecting which economic sectors and businesses to invest in. After heavy falls in the past couple of weeks there is a sense that at least in some instances, the baby has been thrown out with the bath water. In our opinion quality businesses in quality sectors are starting to exert compelling value, offering opportunities to pick up quality businesses at cheap prices.
A sector that offers investors the opportunity to capitalise on a favourable market landscape is the financial services sector. But perhaps against common belief, the best opportunities in the Financial Services sector lay outside the Banks, instead to be found in the diversified financial services space. After all it is these business that are best positioned to capture the burgeoning super fund space. Australia has arguably the most established super fund industry in the world. In basic terms the industry is awash with a growing pool of money that needs businesses to manage it, and that’s where many diversified financial businesses fill the void.
One such business is Challenger Financial. Challenger is the clear leader in the Australian Retail annuity market. The business has significant market share of 80%, providing investment management and retirement income products to a large and growing consumer base. Over the past decade through a solid sales strategy and quality product offering the company has developed strong brand recognition, making it the go-to business for the growing ranks of retirees looking for stable returns in an otherwise volatile investment landscape. It is a widely held view that Australian retirees are underweight exposure to fixed income securities, and CGF’s business is well placed to benefit from the strong long-term annuity demand growth that has been driven by a compulsory superannuation system which is expected to grow to around $7 trillion by 2030.
Challenger has been consistent in its delivery of growth for its shareholders. CGF managed to grow its retail book by 12.5% in 2014, with similar growth expected in 2015. Along with the strong performance of the lifetime annuity products, the funds management business, Fidante partners, has also continued to exceed expectations. FUM has grown by $15 billion, around 30% higher than twelve months ago, taking the total FUM to $45 billion. Despite making up a smaller portion of the overall business, the group is growing strongly and beginning to contribute material growth in the underlying earnings for the company with more upside potential there for the taking.
Although the companies return on equity has fallen slightly in recent years, the figure of 18.6% still remains above management’s medium term target of 18%. The business has managed to grow EPS for each of the past 6 years off the back of a rapid increase in Challenger Life sales, which have increased 140% over a 2 year period alone. With now over $10 billion assets under management the company benefits from significant scale opportunities, while a tight cost cutting approach has also contributed to the ongoing improvements in underlying performance.
Despite a recent setback involving the Department of Social Services which affects the Care Annuity Product, the business has still maintained a healthy profit earnings guidance for FY15 of between $525m – $535m, significantly up on FY14 figure of $481m. With an impressive track record of delivering results, there are few in the market who will doubt Challengers credentials and their ability to deliver going forward. Challenger is in the supreme position to deliver on the opportunity presented by the strong long-term growth in demand for annuities, as a relatively inexpensive, defensive long-term retirement savings products.