On the Money with Dynamic Funds

PARTICIPANTS

Nick Stogdill
Portfolio Manager

Mark Brisley: You're listening to On the Money with Dynamic Funds, the podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders.

Host: It's my distinct pleasure today to introduce to you Nick Stogdill. Nick covers the financial sector for the Equity Income Team and is portfolio manager on the Dynamic Financial Services Fund, and really just an all-around great guy. Nick, nice to see you. Let's just jump into this. Starting at the top of the house, obviously tariffs and trade risks are the topic of the day, but let's begin with your bigger picture view on the financial sector, and then we can touch on tariffs in a little more detail.

Nick Stogdill: You're right. Tariffs are the topic of the day, but I think in financials, it is worthwhile to take a step back. I've been covering this space for nearly 15 years, but if I just look at my time as the lead financial PM on the Equity Income Team over the last two years, there's been no shortage of material risks. If we go back to early 2023, we had the collapse of several U.S. regional banks. A lot of investors thought the U.S. banking system was going to come undone, and that was really taking over the market for 6 to 12 months.

At the same time, there were tons and tons of questions coming in and fear around commercial real estate, the empty office buildings, all the loan exposures the banks had in Canada and the U.S., and could that be the source of the next crisis? It hasn't really played out, although it's not done yet. Then north of the border here in Canada, for the last 12, 24 months, there's been a lot of fear and angst about just higher interest rates and the stress on the consumer and mortgage rates resetting higher, and what impact that would have. I think the first point is just that there's always a worry out there, there's always a new risk, there's always something to fret about. These were material risks.

The second point, though, is that the valuations of the financial sector broadly had been very attractive because of these risks in the last couple of years. The easing of those fears along with better-than-expected earnings growth really contributed to very strong performance across the financial sector. That can be seen in our large equity income team mandates, all our dividend funds as well as the financial services fund, which has had a cumulative return of over 50% in the last two years.

What does make today with the tariff risks different versus the U.S. banking crisis or the Canadian mortgage stress? I don't think we're pricing in as much of the tariff risk into the stocks today. Valuations are much richer. I think the conclusion is we just need to be a little bit more selective on our financial service investments as we look out.

Host: Great. That's very helpful context. Just looking from a higher level, could you walk us through just how some of the various parts of the financial sector would be impacted by tariffs, recognizing there's a lot of complexity in that statement?

Nick: Sure. First and foremost, financial services businesses really aren't impacted by tariffs in Canada or outside in a direct manner. It's predominantly the indirect manner we're all worried about when it comes to this. I'll give you a quick primer on sort of each big subsector and just the drivers. If we start with, again, the Canadian banks, you've heard me say this many times, banks are the plumbing of the economy.

If businesses are going to be impacted by the recent events, it will flow through in the form of lower loan growth, weaker lending, it might manifest itself in the form of higher loan losses for businesses that are directly impacted by trade. Then if the situation becomes more dire, that could spill over to unemployment, it could spill over to loan losses in the consumer side. That's kind of how you think about the big impact on the Canadian banks, and they would be most impacted at the top of the list across the subsectors.

If we look at big Canadian life insurers, Sun Life, Manulife, they're relatively more insulated. They have a high proportion of their earnings and operations outside Canada, probably about 50%, mostly in Asia and the U.S., and so the impact for them, again, is less direct. It's more on the investment portfolios of the life insurers. Again, they collect premiums, they invest them to pay out claims down the road to the extent that tariffs hit markets broadly, equity markets, bond markets, that would be sort of the indirect risk to life insurers.

Moving down further, property and casualty insurance, companies like Intact Financial, Fairfax. Again, I think they are relatively insulated. Insurance is a must for most consumers and businesses. It's relatively domestic oriented, and it does reprice annually, so this group would probably fare best in some sort of macro tariff-related event. Look, there are concerns in that space as well.

Auto parts inflation, if we're worried about the auto trade cross-border, and auto parts go up, that would obviously hit repair costs, but the nice part for the P&C insurers is they can just reprice the auto policies year to year. Again, we would all see our premiums go up as consumers, but there's offset mechanisms for those companies. Then lastly, I think it's important to touch on our non-Canadian holdings. Again, the businesses we own across the equity income team and the financial services team are diversified across Canada, North America, and outside North America.

Many of these businesses are likely to be unimpacted from tariffs. If we look at U.S. banks, for instance, it's really a call on the U.S. economy. I don't think that's going to throw a wrench in it. It could, but it's really the economic outlook for the U.S.. If we think about alternative asset managers, which are important holdings for us. Weaker investment markets, bond markets, stock markets, that would translate to lower investment returns for them as well, even though their investments are largely private, so that could manifest itself that way.

Then, again, a lot of businesses like exchanges and data and analytics companies that are relatively unscathed in the event of any sort of macro dislocation, whether it be tariffs or something else. In some instances, these businesses might benefit from the increased volatility, actually. There are some offsets for some of these non-bank businesses.

Host: I think it's important that we dig a little deeper in some of the subsector comments there, Nick. Canadian banks alluded to as the most likely to be at risk within financials. Can you elaborate a bit further on that?

Nick: Yes, sure. Again, anything that hurts the Canadian economy hurts the banks, full stop. Tariffs or any other major macro event will hurt Canadian banking. I think, look, there's more nuance than that, and that's where you need to dig down. Again, you can look at BMO and TD, 40% to 45% of their earnings come from the U.S.. Royal, CIBC, National, it's probably more in the 15% to 20% range. Then there's Scotia with around 10% of earnings from the U.S. and 10% from Mexico.

Again, it's easy to strike them all with the same brush, but you can see as you dig down, there are differences in the earnings mixed by geography and region. Again, simplistically, the answer would be, "Oh, I want to own more of the banks with the U.S.," but if you go another layer down, BMO's business outside Canada and inside Canada, for that matter, predominantly skews to commercial and business lending, whereas TD is more consumer-oriented south of the border. Again, if you have a view on businesses being more impacted as the first-order impact, that's another thing to consider in your allocations and your holdings across banks.

I think the real point is you have to really drill down and you can't just paint them all with the same brush. It just means you're probably going to see greater dispersion across the banks as we go forward. Even in the last two or three years with all the volatility, we've seen greater dispersion within the banking group in Canada.

Host: Could you quickly touch on this recent narrative about U.S. banks allegedly not being able to come into Canada and operate in Canada?

Nick: Yes. It's a funny question that obviously came from Trump. His claim that U.S. banks can't do business here, I think, is a bit misleading. I'll give you three quick points. First, the U.S. banks are here. The big U.S. banks are here. It's just not in retail banking. If you look at the equity and debt league tables for capital markets issuance, Bank of America, Goldman, J.P. Morgan, they're all there in the top 10 to 15. Wells Fargo is here as well. They are here. Secondly, it's more on the retail banking side. The reality is I just don't think our market is big enough for them to build a presence.

To give you some context, J.P. Morgan has around 4,900 branches across the U.S., just J.P. Morgan. Our entire banking system in Canada is about 5,600 branches. Again, you look at the scale and size, and it's hard for them to justify coming here and building a presence. Then thirdly, I think if you look across many of the major markets globally, banking is largely a domestic business. Europe, each country has their national champions. Australia, it's the same thing. China. Obviously Canada. It's actually that way if we look at the U.S. market too. The reason for this is just that each country wants to ensure financing is available for the economy.

Banks are strategically critical infrastructure, and you can't risk a foreign bank pulling out when domestic businesses, governments, and consumers need it most. If we throw out a crazy idea out there and say, "Hey, J.P. Morgan should buy CIBC." Well, it'd be risky to have a foreign bank hold roughly 10% market share in Canada because they may choose to pull capital when it suits them and it might be at the time when we need it most. That would be pretty detrimental to the Canadian economy. That's why banks tend to be domestically oriented businesses.

It's funny because if you actually look at the U.S., BMO's and TD's operations, for all the money and billions of dollars they've spent, they really only have 3% to 4% market share. If you look at the U.S. banks in the U.S. market, the top five control two-thirds of the market. The U.S., for all intents and purposes, is still a domestic-oriented market.

Host: Nick, the million-dollar question, where does this all leave you on Canadian banks, on balance, are you positive, negative?

Nick: Look, I touched on my concerns. It's just, on the tariffs, I don't think on the near term that the tariffs are properly reflected in valuations, and that gives me a bit of pause. I think, again, if you take a longer-term approach and look out further down the road, I'm actually quite optimistic. The negative sentiment can be felt everywhere, both in the country and when you travel outside Canada.

Canada is clearly out of favor. We all know productivity and growth are weak. The currency is in the dumps, foreign investment flows into Canada are anemic. All this negativity can hopefully lead to a pivot in our government and their regulations, the bureaucracy, our tax rates, and put Canada back on a better track. Look, that would be fantastic for the Canadian banks, if you go three to five years down the road. Look, I think the advisors that are listening on the line, they have an important job, and that's just to ensure their clients stay invested and don't get caught up in this negative sentiment that you hear and do feel everywhere today.

Host: Thanks for your thoughts, Nick.

Announcer: This audio has been prepared by 1832 Asset Management L.P., and is provided for information purposes only. Views expressed regarding a particular investment, economy, industry, or market sector should not be considered an indication of trading intent of any of the mutual funds managed by 1832 Asset Management L.P.

These views are not to be relied upon as investment advice, nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions, and we disclaim any responsibility to update such views. To the extent this audio contains information or data obtained from third-party sources, it is believed to be accurate and reliable as of the date of publication. 1832 Asset Management L.P. does not guarantee its accuracy or reliability.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed. The indicated rates of return are the historical annual compound total returns including changes in unit values. Their values change frequently, and past performance may not be repeated.