For the disciples of Messrs Graham, Dodd and Buffett, the current market, particularly here in the UK, has thrown up some interesting anomalies.
A case in point is a small investment trust where the discount between the share price and the net asset value looks to be out of whack with reality.
EJF Investments Ltd (LON:EJFI), like others in the sector, fell victim to the indiscriminate sell-off at the start of lockdown as global markets began to tank.
The fact the share price hasn’t righted itself as normal service has been resumed looks odd.
To understand why the market may have got EJFI all wrong you first have to know what it does.
It is invested in the financial sector, specifically insurance and ‘main street’ community banks in the US with an emphasis on the latter.
It is fair to say the average Brit’s grasp of the minutiae of the American banking system is hazy, to say the least.
Add to that the fact that EJFI invests mainly in credit instruments, and there’s another layer of complexity that soon has some investors glazing over.
In the US, balance sheets have become almost bomb-proof, and there’s the added protection of the Dodd Frank Act that’s improved accountability and transparency.
Post-pandemic, legislators have sought to bolster the financial system, while supporting consumers in a way unimaginable during the crisis of 2008 onwards.
It means, rather than posing an existential threat, US banks are in financially decent shape.
In fact, they are part of the solution as dispensers of stimulus support for people and businesses.
At the local level at least, consolidation is the watchword, providing a boon to those holding bank debt and equity alike.
Regulation, meanwhile, is expected to be benign if not supportive.
With a small bank in just about every congressional district, legislation such as the 2018 Regulatory Relief Act, amending and updating Dodd-Frank, received bi-partisan support (which is almost unheard-of in the Trump era).
“If Joe Biden wins the election, which it looks like he will, we do not have any concerns about the small community bank space; the regulatory outcomes are unlikely to change for the worse,” said Neal Wilson, chief executive of the trust’s manager, EJF Investments Manager.
“It may slow down mergers of the regional banks, the larger banks. But that’s about it.”
If much of this is misunderstood by the predominantly UK investor base there is a further misapprehension about EJFI, said Wilson.
He suggests the trust is being lumped in with highly leveraged investment firms that invest and trade in collateralised loan obligations (CLOs), which traditionally carry a different risk profile than the trust.
EJFI’s focus is on the buying and holding of the less risky but still financially rewarding equity element of collateralised debt obligations (structured finance product that is backed by a pool of loans).
A look at the company’s performance up until the end of March reveals the stock traded at or above net asset value since listing in 2017.
During the crisis it was one of the few in the sector to maintain its dividend.
According to its latest presentation, EJFI is targeting a total annual pay-out of 10.7p a year, which represents a very plump 8.8% yield at current prices.
At the same time, it is targeting a NAV total return of 8-10% pa.
Underlining the manager’s faith in the long-term potential of the trust are two elements.
First, it has pledged to cover a minimum of 75% of the EJFI’s operating expenses until it reaches net asset value of £300mln; and second, the principals have significant skin in the game. Also, the manager is not new to this – it has issued 11 post-GFC securitisations backed by assets of over $3bln, and prides itself on being an expert in the financial services sector. For specialised investments in particular, the know-how and resources to read the markets and the regulatory tea-leaves matters – a lot.
EJF Investments Manager owns roughly 24% and expects to maintain a high level of ownership going forward.
“So, we’re always going to be incredibly aligned with shareholders and we are constantly putting more capital each time we do a securitisation,” said Wilson.
At the end of June, the last time the industry body the AIC calculated the figure, the average investment company discount to NAV was 8%. EJFI’s share price is currently trading 28% below the net value of its portfolio.
That prices the stock for a significant downward re-rerating in US community banking (and the credit markets supporting it) that shows no signs of materialising. Yes, the economic backdrop is tough, but not that tough, Wilson and his team would contend.
“We’ve had no credit issues whatsoever during that timeframe [since lockdown],” Wilson explained.
“That was not a surprise to us because the government’s support for the banking system was considerable and immediate.”
“This is not like ‘08/’09 where the banks were the problem. The banks come into this situation with roughly double the equity levels they had then.”
One suspects it is only a matter of time before value investors begin to appreciate this and the discount unwinds.