Investing in Financials with the Goal of Downside Protection
Hennessy Large Cap Financial Fund
Dave Ellison, Ryan Kelley
Author: Ticker Magazine
Last Update: Mar 09, 10:45 AM EST
|As a result of the 2008 financial crisis, investors are still cautious about banking stocks. However, for Dave Ellison and Ryan Kelley, co-managers of the Hennessy Large Cap Financial Fund, the financial world provides plenty of opportunities. Running a concentrated portfolio, they focus on choosing the companies with the right business models, repeatable earnings, and management teams with the ability to withstand the storms in the credit and interest rate cycles.
ďThe financial industry isnít one that can significantly transform itself. This is a commodity industry thatís been around for 1,000 years; it has seen the ups and downs of cycles and is very much tied to an Apple or a Facebook. They piggyback and prosper from those innovations.Ē
So, for us risk is about a significant change in the earnings outlook, which boils down to the business model and the credit culture. Thatís why we focus mainly on those two aspects.
Valuation is important in the context of current events, but in a historical context, itís really not that relevant. Whatís truly relevant is to make sure that earnings donít suddenly drop dramatically because a certain portion of the business model blew up overnight. We donít like complexity in business models, while some leverage is tolerable.
Another risk measure is the construction of the portfolio itself. The limit of 5-6% in individual positions and the liquidity that we maintain are important. Cash is a big part of the protection process and, at one point during the 2008-2009 credit cycle, we had north of 50% in cash, because the environment was not healthy for financial stocks.
Generally, we manage risk by staying conservative on the types of companies we own to strive for protection on the downside. The stock-picking process is one of elimination, not inclusion. By eliminating companies, we pick only the ones that we believe lack vulnerabilities over a cycle. Sometimes we eliminate a name primarily by looking at its business model.
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