he more or less took it in stride when the regional bank crisis unfolded in March .
For starters , regional banks weren ’ t part of his fund ’ s large-cap portfolio . Second , he and fund co-portfolio manager Pierce Crosbie had already anticipated the trouble : They had flagged the interest rate risks being taken by certain banks and they had called out First Republic by name , before it turned out to be one of three recent high-profile failures .
Not Feeling The Love
While the Davis Financial Fund includes insurance and other financial services firms in its portfolio , banks represented the fund ’ s largest industry weight at nearly 45 % as of this year ’ s first quarter . In recent years , Davis and Crosbie had noted in their newsletters how historically low interest rates had suppressed bank earnings by squeezing the spreads banks could earn on customer deposits , and said that the inevitable rise in interest rates would act like a coiled spring to unleash greater earnings potential . That came to fruition over the past year as the Federal Reserve increased the fed funds rate by 500 basis points from March 2002 through May 2023 .
But Davis says some banks benefited more from this than others depending on how management had positioned their companies . In particular , he notes , the likes of JPMorgan Chase and Wells Fargo saw dramatic increases in interest income while simultaneously minimizing their balance sheet risk as rates increased .
Manager Chris Davis Age 59
“ We ’ ve seen companies that took irresponsible interest rate risk pay the price . We ’ ve seen deposits flow out of those institutions and into institutions that are safer , larger , have better accounting standards , more capital and took less interest rate risk . So money is flowing into the Wells Fargos and JPMorgans ,” he says .
But investors have seemingly yawned and haven ’ t taken much notice . “ We thought the stocks of the banks that are well managed and well positioned would be benefiting from this , not just relative to the other banks but relative to the market as a whole ,” Davis says . “ And that hasn ’ t been happening .”
Indeed , the Financial Fund was down 2.5 % this year through June 5 while the S & P 500 gained 11.3 %. Davis adds that explains . “ And as we head into a [ possible ] downturn the banks are incredibly well-positioned except for those mismanaged banks that took catastrophic interest-rate risk .”
He believes some investors remain wary of banks because of their role in creating the financial crisis of 2008-2009 . “ In the meantime the capital and earnings are piling up in these [ well-run bank ] businesses ,” Davis says . “ There ’ s no fundamental reason for these stocks to be down ; they ’ re down due to psychology .”
While the Davis Financial Fund includes insurance and other financial services firms in its portfolio , banks represented the fund ’ s largest industry weight at nearly 45 % as of this year ’ s first quarter .
he thought the Covid-fueled recession would begin the upward re-rating of the largest , best-of-breed banks because they proved their strength by providing liquidity that helped the economy rebound quickly .
“ But because that recession was very short-lived there wasn ’ t a sense of how resilient the banks have become ,” Davis
Professional Background He joined Davis Advisors in 1989 . Besides overseeing the Financial Fund , he is also a portfolio manager for the Davis Large Cap Value Portfolios and a member of the research team for other portfolios . Before joining Davis Advisors he was a research analyst at Tanaka Capital Management and an accountant at State Street Bank And Trust Co .
Outside Interests He is a long-serving trustee at the American Museum of Natural History and the Hudson Highlands Land Trust . He enjoys spending time with his children and grandchildren on his farm in upstate New York and on his old wooden sailboat in Maine .
Recession Concerns
Some investors are spooked by banks because they fear a possible recession following the Fed ’ s aggressive interest rate hikes . For Davis , that presents opportunities in select banking names . His confidence in those names is summed up in two words : “ stress test .” In other words , they ’ ve had to run with strict guardrails in place since the financial crisis .
“ When we went into Covid they moved the goalposts and made it even more severe , and the banks still passed ,” he says .
Nonetheless , even if the U . S . avoids a recession some investors are concerned about a potential crisis in the wobbly commercial real estate market . Davis counters that he and Crosbie are comfortable with
Portfolio Statistics
# Of Equity Positions 25 Average Mkt . Cap
$ 51.4 billion P / E Ratio 9.2x Std . Dev Fund / Benchmark 22.86 / 21.76 Turnover Ratio 10 % Net Expense Ratio 0.72 %
Stats as of 3 / 31 / 23 . Standard deviation ( three-year period ) versus the Morningstar U . S . Financial Services TR USD as of 5 / 31 / 23 . Fund turnover as of 12 / 31 / 22 . Expense ratio figures are for the institutional Y-share class . Sources : Davis Advisors and Morningstar .
PHOTOGRAPHY COURTESY OF DAVIS ADVISORS JULY / AUGUST 2023 | FINANCIAL ADVISOR MAGAZINE | 47