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Transcript: The Lowdown On Insider Trading, The Upside Potential In Europe, And The Ins And Outs Of UK Bank Shares

With the US authorities alleging one prominent mega hedge fund is riddled with insider trading,  should everyday investors like us assume the game is rigged? Back on our side of the Atlantic, European shares struggle to get anyone to buy them. So is now the time for contrarians to go shopping across the Channel? And what should investors make of the latest news from Barclays (LSE: BARC) (NYSE: BCS.US), Lloyds (LSE: LLOY) (NYSE: LYG.US) and HSBC (LSE: HSBA)? Owain Bennallack invites Fool analysts Nate Weisshaar and Mark Rogers to share their views on all these topics, plus their latest thoughts on three interesting companies: Sage, Pace and Jupiter Fund Management.

The following is an unedited transcript of this Fool podcast:

Owain:

Hello, and welcome to Money Talk, and our monthly investing roundtable here at The Motley Fool.  I’m Owain Bennallack, and with me in the studio today we have Nate Weisshaar from our Champion Shares Pro and Share Advisor services, and we have Mark Rogers, who’s our newest advisor here at The Motley Fool, and he’s invariably our most respectfully-dressed one. Welcome to the studio, guys.  Mark, it’s sunny, but you’re in a jacket again.

Mark:

Yeah, notice that I tend to wear this in all weathers.

Owain:

Keep up your standards.  You’re trying to set yourself out, so when they write the biography of Mark Rogers, value investor supremo, they’ll have a hook to hang their thesis on, like you don’t hang your jacket on in fact, because you’re always wearing.  You’re speechless – I was hoping you’d come back with a sort of witty comment there.  Nate, you’re rocking a summery t-shirt.

Nate:

I’ve got three in my wardrobe, so it just happens to be the green day.

Owain:

It’s green day today.  It is the second half of the year. All through the first half, anything bad that happened, anything at all, we’re told to wait for the second half.  Apple, for instance, we constantly heard that was a second half story.  The US recovery was supposed to get through this sequester, and be a second half story.  Nate, are you geed up for the second half?

Nate:

It’ll be interesting to see if Apple has something for us in the second half, but other than that, I think the first half’s been pretty good.

Mark:

There’s some interesting green shoots out there in terms of, business activity seems to be picking up.  I’d be interested to see how the second half works out.

Owain:

Yeah, I mean these are just calendar effects, but we need to keep an eye on them, if only to sort of explore the evolving narrative if the markets come back, and subsequent collapse, and around we’ll go for three or four decades.  Enough of the future, listeners – let’s stick with the present.  In the newsroom, they call this time of year, as you can probably tell from this extended preamble, the silly season – stories about penguins that can water-ski, grandmothers that get into Zumba (it’s a fitness craze, Mark).

Mark:

My girlfriend does Zumba, so at least I know. She’s not a grandma, by the way.

Owain:

Mark – Zumba, that’s the new material, Mark.  You’re feasting on Gregg’s pastries, while she’s at the Zumba class.

Mark:

Kim will really appreciate me mentioning this, by the way.

Owain:

That’s brilliant. Maybe we’ll get her in for a video?

Mark:

She would like that.

Owain:

It’s an investable – is there any investing angle on Zumba?

Mark:

No, but she knows her biotechnology companies, more than I do.

Owain:

And far more than we have at the moment, which is less than, it’s only about 70, 80%. Wow, she’s coming in!  But we’ve had enough of the Gregg’s banter, Mark, so I think we’re going to have to get a new podcast guest. It’s a silly time of the year, but we’re contrarian, so we’re going to be serious.  We’re going to look at the serious matter of insider trading in the US, but obviously it can happen anywhere.  We’re going to look at the potential or otherwise – I’m looking at you, Nate – for serious profits in Europe in the next couple of years, as that continent pulls itself out of the mire; and we’re going to look at the seriously shifting fortunes of the UK’s biggest banks.  And then, after all that, if there are still any batteries left in the recorder, we’re going to run through three companies that we’ve got our eyes on this month.

Mark:

It sounds good.

Nate:

It sounds good to me. 

Owain:

Right well let’s do it.  Let’s get going, and I’m going to start with insider trading.  In the US, the massive US hedge fund, SAC Capital Partners – I’ve just realised, they never abbreviate that to SAC Capital Partners.

Mark:

I wonder why?

Owain:

It’s probably more appropriate now. SAC Capital Partners has been indicted for criminal fraud charges.  US prosecutors have claimed that the multi-billion dollar hedge fund, double-digit billions, it has became a “magnet for cheaters”, who undertook “systemic insider trading that was on a scale without known precedent in the hedge fund industry” – serious charges.

Nate:

That’s quite a quote.

Owain:

It is a quote.  As an aside, they do come out with these incredible, it’s like when they did Standard Chartered last year for the money-laundering, and you would think that they were all in league with pirates in Somalia – Somalian pirates.  It takes you back to the nineteenth century.

Nate:

Well, everyone needs to grasp their fifteen minutes of fame, so they’ve got to make these soundbites as exciting as possible.

Owain:

I suppose it is that.  SAC’s boss, Steve Cohen, he came to prominence in the 1990s through his apparently brilliant stock picking skills, which were enough to make him a billionaire.  Obviously, some of that billionaire-making was because he did some stock picking for other people, and became a hedge fund manager.  We don’t know, and we’re not claiming to solve for the US government, we’re not going to save them a few million by telling them today whether these allegations are true or not – what I’m interested in today, really, is whether the fact that this has come to light, ten billion dollar hedge fund, fourteen billion thereabouts, many billions – the fact that it can be indicted, and be said to be “undertaking systemic insider trading on a scale without precedent in the hedge fund industry” – how are we supposed to take this, as investors?  Is the entire game rigged against us?

Nate:

I don’t know if I’d go that far, but it definitely does cast a bit of a pall over the whole industry.  In a more reassuring note, we do have the authorities trying to crack down on this, and we’ve seen some progress being made. We’ve seen some convictions, insider trading charges, and now they’re going after the big boy.  This is really, not only is it a headline-grabbing accusation, it’s going after the biggest player, and has been claimed as the biggest …

Owain:

Biggest dose of insider trading!

Mark:

So you think they’re sort of making a statement really?

Nate:

The biggest perpetuator of insider trading.

Owain:

Alleged perpetuator.  Yeah, I mean, if these allegations are true, then they’re showing nobody’s untouchable, I guess.

Nate:

I think that’s exactly what they’re trying to do here.

Owain:

I saw that our US colleague, Morgan Housel, posted an article on The Fool in the US.  He suggested, with a bit of data that he’d got, that there was an explicit link between the crackdown on insider trading, which you’re referencing, Nate, and the sharp decline in hedge fund returns since 2009.  He pointed to FBI investigations; he says there’s been some 70-odd arrests, and as you say, some convictions.  I have some queries about that connection personally, but do you think that there’s any truck in that? Do you think that this crackdown is, in fact, stopping people phoning up their friend at a company, and saying, how are the results going to look next week?

Nate:

Well, that would be the reassuring conclusion.  I can’t say whether it’s true or not. I’m sure that there are some people who have been dissuaded from this activity by the potential for being arrested, but I also think that the hedge fund industry itself has become an incredibly crowded space, and any time you see lots and lots of people trying to pursue a similar strategy in the financial market, those returns shrink rapidly

Owain:

Plus they all got it wrong.  They all thought the bull market was a fantasy, and they may still be right, but not so far, hedgies.  Mark, obviously we’re against insider trading 100% here at The Motley Fool, but, and this is a measured but – is there an argument for saying that the sort of legendary investor, Phil Fisher called “scuttlebutt”, is going to be caught in this crackdown? Scuttlebutt is the idea that you kind of get information that isn’t already in the market, and if these hedge funds are hesitant to use any information that doesn’t come 100% through official channels, RNSs, that kind of thing, could that actually not make the markets less efficient, and then actually be bad for us as investors?

Mark:

Well, on that last point, I think efficiency, or at least informational efficiency, implies that all the knowable information there is about the security is in the market, and that it is at least reflected in the price.  I think what we’re seeing here would be more of an inefficiency, and it’s certainly not an efficiency that’s beneficial to ordinary investors, if you want to look at it from that point of view.  I think there’s a fine line between digging for information, scuttlebutt if you like, and insider trading. I think there is a definable line there.

Owain:

It’s curious, though, whether there is a definable line.  One of the things that SAC has been accused of is deliberately recruiting people from an industry that it’s looking at, so those people have left that industry to come and work for SAC.  Now, I agree that, if you take out the CEO yesterday and employ him in SAC, and then pump him for information, clearly that would seem to be inappropriate, but if he left six months ago, how can you define this line?

Nate:

It gets a bit fuzzy there, but I think that the line becomes technically defined as material information that isn’t available to everyone at the same time.  There’s been plenty of regulation to try and dissuade this type of information, but there is always going to be talk between analyst companies, companies and their spouses.  There’s just no way to halt it, but there is a way to put the institutions in place to minimise the impact.

Owain:

Get rid of the biggest abusers.  Well, one place where there might not be much insider trading going on at the moment is in Europe, because it seems to me that very few people want to buy any European shares whatsoever.  I have said that, but the big consumer staples like Nestlé, some of the luxury brands, big exporters – some of those companies remain popular.  But elsewhere, the existential crisis in the Eurozone has left the more cyclical companies, and even more so the financials, looking distinctly unloved by insiders, or anyone else. Mark, I put it to you, and I’m sure you’re going to come back and let me know if I’m right or not, that there have been a few outbreaks of optimism in Europe, though?

Mark:

I certainly think that, compared to this time last year, where you would struggle to find a single positive word being said about the entire continent, I think compared to that, we’re in a situation now where business activity is at least not deteriorating at as fast a rate as it was. The rot has been stopped.  I think if you look at certainly the purchasing manager indices, that is implied, and I think there’s certainly a case to be made that there’s a chance that some of these cyclical names may well be undervalued.

Owain:

Well also, on the point of the financials, those countries in the periphery aren’t seeing their bonds stressed at those elevated levels that we saw before Draghi stepped in, and that possibly bolsters the case for those shares. 

Mark:

Certainly, and I think, going back to the bond point, especially the peripheral effect, there was real fear in the market at that time, a real rush to get away from and disassociate yourself from these bonds, if you were an institutional investor.  I think what Draghi did was absolutely necessary, and that’s been vindicated in the market.

Owain:

Well, I know that reasonable minds, as they say, can disagree on this, but I really do think that European share prices are not banking on very much good news at all.  I’m not counting markets like Switzerland as part of Europe; I’m not even counting, Nigel Farage will be pleased to hear, the UK, although I don’t think the FTSE looks that expensive.  But certainly compared to the US, it looks fair value, and countries like Spain, Italy, even France and Germany to a lesser extent, those PE ratios there are at or below average levels, compared to the US, where they’re significantly above the long-term trend.  Nate, why would you not be shopping in Europe now, instead of back home, where everything costs double?

Nate:

Well, I don’t know that I wouldn’t be shopping, but I’d be shopping with a discerning eye.  There’s often a reason that PE levels get depressed, and despite a slight uptake perhaps in trends through Europe, you’re still looking at significant amounts of unemployment throughout the periphery, and even France is still struggling.  I don’t know that the markets may not be pricing in a whole lot of optimism, but there’s also not a whole lot of evidence that there should be optimism.  So I think Europe may not be in its darkest days, but I’d say it’s far from out of the woods, and you’re always going to be able to find a high-quality company.

Owain:

Just to interrupt you there, before you run ahead, because I’m going to pre-stage my next question, but what I would say is, if investors have decided to bid up US shares, Japanese shares, these companies around the world, in expectation that their economies are going to improve, and that that will be good for growth in general, that’s got to, at the very least, be good for European exporters, plus from a behavioural point of view, as Mark says, I don’t think that the attitude towards Europe could get any worse than last summer, on the evidence.  Obviously, it could get a lot worse, if somehow any of the other 25% of Spanish people who have got jobs lost them, but from where we’re standing now, people were so pessimistic, they were talking about the complete destruction effectively of the Eurozone as an entity.  We have signs of growth. No country has left the Eurozone. The only way is up, is it not, Nate?

Nate:

I would hope so.  Like I said, the darkest days are seemingly behind us, so up seems to be the direction we’re travelling, but I think the slope is going to be slower than we may be expecting.  But again, there are high-quality companies speckled throughout Europe who don’t have their fortunes tied to the economies of Spain or Portugal, so I think there are opportunities out there, and if you want to put the legwork in, you’ll be able to find good places to put your money.

Mark:

Yeah, I think you have to be relatively objective, and take a longer-term view that things, over the course of time, will eventually get better in Europe, and there are a great many European companies that do their business around the world, where there may be opportunities if the price is right, and I think that is going to be the big question.

Owain:

Yeah, I don’t want to hog the entire podcast with my pet thesis, but if you say Fiat, which I own the shares of, and you’ve got now a sustainable business for a couple of years in the US, and yet European car sales were at a twenty-year low, then if they get back to fifteen-year low, that’s all bolt-on profits, when you look at the comparisons year over year.  That’s what I mean by the only way.

Nate:

But that assumes Fiat gets those sales?

Owain:

Well, it does.  I’m going to go out and buy a Fiat car.  It probably would make a difference in their current results.

Mark:

I tried that with Greggs – it didn’t work.

Owain:

That’s why you’ve also force-fed your poor girlfriend, and she’s had to go to  Zumba classes to deal with it.  So Europe isn’t the only place where investors are being advised to pick carefully between the winners and losers.  In the UK, the big UK banks, they’re having a very different summer, depending on which bank we’re talking about – right, Nate?

Nate:

Yeah, we’ve seen results run the gamut.  Lloyds came out and pleased everyone with a nice, profitable first half, and some very optimistic words for how quickly they’ll achieve the turnaround of Lloyds, and potentially the sale of the government’s stake.  On the other hand, Barclays went to the market to raise five billion pounds, which is a less encouraging action, although it does set them up going forward to meet regulator demands.  Shareholders probably aren’t too pleased with this situation. Then you’ve got HSBC, which, its global reach makes it less vulnerable to issues here in the UK, but management’s comments weren’t exactly the most optimistic. They admitted that emerging markets are slowing, and the market didn’t really like that. They were in the mood for good news.  HSBC got hurt a little bit for that, but I think, and management said, the long-term trend still seems to be there.  It just won’t be as robust and as exciting as some may have been getting used to.

Owain:

Yeah, and then we saw Standard Chartered come out with maybe some slightly stronger than expected results?

Nate:

Yeah, there was a lot of pessimism around Standard Chartered, and while they said essentially the same thing that HSBC said, it’s all about perception.

Owain:

What I find particularly interesting about this is, before the crisis, lots of investors used to just hold big blue-chip banks. They were advised by financial advisors, or banks, or newspapers, these were a safe way to get income – as if a bank could go bust.  We saw how that ended, and now it seems that, in this post-crisis era, we’re again seeing that not all banks are equal, especially not on results day.

Nate:

That’s definitely the case, and I think it’s a mistake to paint any participants in an industry with the same brush, just as it’s a mistake to paint any countries that are neighbours with the same brush.  All emerging markets are not the same, and all banks are not the same.  Banks are a reflection of their culture, and how they take on risk, and how they comport themselves with their assets and lending. 

Owain:

Do you think that that will continue, even with the greater regulatory oversight.

Nate:

I think it will always be the case.  Regulators can write as many rules as they want, and they can lean over every banker’s shoulder if they want, but the banks will always be a reflection of the corporate culture, and it comes down to who is running the bank, and how conservative they are. 

Owain:

Mark, Lloyds’ CEO recently said that he aims to pay out 70% of earnings, I think it was, by 2015 as a dividend.  That’s like a utility – that’s why you buy shares in Scottish & Southern or whatnot.  Is this bank becoming boring enough for you?

Mark:

The problem for me isn’t so much whether or not it’s going to become boring or not, but it’s a difficulty that I find personally with coming to a valuation as to what Lloyds as an entity is worth, and what I’d be willing to pay to guard myself against overpaying for putting a price on it, is my concern.

Owain:

OK, well I think it’s fair to say then, that I remain the biggest enthusiast for bank shares amongst us yet again.  Let’s turn instead to shares that you are more interested in.  Mark, sticking with you, what are you watching?

Mark:

So a company I’m looking at at the moment is Sage Group. They are in the software business for small/medium-sized enterprises, and they have accountancy software, business software. What I like about the Sage Group is that I think that they’re pretty well-embedded in their industry.  It’s kind of difficult to shake off their software, once you start using it.  They have great repeat revenues from their subscription business. I quite like the company.  I think it’s reasonably priced as well.

Nate:

Well, being in the tech industry, obviously Sage is more susceptible than some to disruption.  Obviously recurring revenue and being embedded is a competitive advantage, but tech companies are always at risk of being undermined by the latest, greatest. How is Sage reacting to the current shift in cloud computing, mobile computing, freeware from Google?

Mark:

Yeah, those concerns are absolutely what I’d be looking at with any technology company.  Sage is more my type of software company, if there is such a thing.

Owain:

It’s boring?

Mark:

It’s boring – software is very boring.  It’s not trying to reinvent the wheel.  It’s effectively the same software – I’m sure they’d be complaining if I said this, but fundamentally it’s the same software that they’ve had in place for a great many years.  People get used to using the software, and it becomes, like I said, pretty difficult to shake off, and I feel that at least the record so far stretches back maybe ten or fifteen years, vindicates that I think that it might be a little difficult to get out of their market position.

Owain:

Yeah, they would have had competition before, in a different form.

Mark:

Certainly, and like I say, with Google offering free software, that’s bound to be a threat, but I think Sage has been dealing with that for a few years now, and I think they’re holding up relatively well.

Owain:

OK, Nate – picking on Mark like that, his pick of Sage. Let’s see what you’ve got.  I presume you’re not going for a massively over-leveraged Italian bank?

Nate:

Well, I guess if you won’t let me.  I’ve been watching Pace, which is now the world-leader in set-top boxes, and what they call gateways – they’d be those boxes you plug into the internet, to bring your broadband into your house. So these are essentially the entertainment and information doorways for your house, and Pace is the world-leader in these.  It’s a tricky industry, relatively commoditised, but Pace has been making innovations and winning contracts with the likes of Sky and Comcast in the US. So they’re supplying the big boys with devices that allow us to watch our favourite shows.

Owain:

Well Nate, I’ve got a problem with Pace shares.  It’s not that they were 50p or similar two years ago. Companies can clearly push on to better things, and that can be reflected in the share price that’s what – six-fold higher, or something like that?  But I’m not putting on my hindsight glasses there. What I’m suggesting is that we’ve seen, the shares were a lot higher than 50p before they got to 50p, and then they’ve come back; ie, this is a company that can be hit by massive fluctuations in its business fortunes, seemingly out of the blue.  Would you be confident buying here, given that one of those incidents could be around the corner?

Nate:

That’s why I’ve said I’m watching. The company obviously has had issues in its past, some self-inflicted, and some acts of God literally.  The floods in Thailand wiped out one of their major suppliers, and essentially crippled nine months’ worth of production, so that’s when we saw the shares down around 45p. But I have been impressed with management, the new management team’s delivery of their strategy, and they seem to be making good on their word, and their margins are holding up, which was one of the major concerns that I had with them.  They think they can go further, but the fact that they are now the market-leader in all three of their categories, and that one of the big threats that I saw was Google’s acquisition of Motorola, who was the number two in set-top boxes, but now Google has sold off that aspect of the business, and we haven’t really heard much from it.  So I think Pace is establishing itself, and it’s one I’m re-examining, because I had passed on it. But if management can deliver what they’re saying, the shares look like they’re very cheap. They’re trading on seven times’ free cashflow, and as you say, there aren’t a lot of expectations priced into the shares, and so it’s one I’m looking over right now.

Mark:

In a more broader sense, in terms of where they stand in the value chain, is Pace a little too reliant on a few big customers, and are they under pressure in terms of the prices they can command from those big customers?

Nate:

They definitely have issues with being able to command prices, which is one of the reasons they’ve moved away from just set-top boxes into these gateways, and into some software aspects of home entertainment as well.  So they’re making moves to alleviate that pressure, but the fact that they’ve been able to innovate the devices, and sell next-generation, essentially re-up contracts with these major entertainment companies, is encouraging. So it’s definitely something to watch, but they seem to be doing fairly well.

Owain:

OK, well that just leaves me, and I won’t be going for a bank this month either, because we’ve done those.  I think I’ve made my case on banks many times.  But I’m going to look over a financial company, and that is going to be Jupiter Asset Management.  What I’m going to suggest about Jupiter Asset Management is that I was surprised by their recent results.  I was reassured by their recent results, because the business seems to be entirely on track.  Assets under management were up to £29 billion from £23-and-a-bit billion this time last year.  Profits are growing really rapidly.  Earnings per share were up to 12.5p, 12.4p to be precise, from 9p.  Net cash was up a lot, and this is important, because when they floated, they were burdened with a lot of debt, and the markets have been good recently, but they haven’t been universally good, and yet the company has continued to dump cash – what’s the word? – slough off cash, I suddenly couldn’t remember how you said it, where you shed it?  It spouted cash, which it’s used to pay off its debt load, so it’s a much safer company than it was a few years ago, and all of this gave them the confidence to raise their dividend by 40% to 3.5p for the half-year. The CEO is Edward Bonham-Carter, who is the brother of the famous actress.

Mark:

A nice bit of trivia, actually.

Owain:

I commend it to the house.  What I think was interesting about this company was, worried that we might seen an impact from RDR. We might see that the changes in the rules about how you can distribute and market your funds would have impacted their inflows, but it doesn’t seem to have hurt them, so I think this business may well be set fair for the next couple of years.

Mark:

Yeah, that would be my question, in terms of RDR and different regulatory changes.  In terms of the fees that they’re able to charge, is there a risk that that might change in an adverse way for Jupiter?

Owain:

Yeah, I think that’s exactly the right question.  I think what these half-year results have shown is that they can still market their funds and get people into them, and keep people in them. What it hasn’t necessarily shown us is what that’s going to deliver over the next few years, because of course investors are going to see those costs much more clearly now, and they’re going to have to decide whether Jupiter’s worth the money, so a lot of their funds are beating the market.  I don’t want to turn this into an advert for Jupiter Fund Management, but they do seem to be delivering.  They claim to put performance at the top of their agenda, which they’d have to do, I guess.  But it’s certainly something that all their rivals are also going to face.  So, I don’t have a good answer for that.  I think that probably, when you come to look at the shares, and you have to value them, you definitely have to take into account that some profitability of running these assets might not be quite as high in the future as it was in the past, but we possibly could take half a position now, and then wait to see how that plays out over the next couple of years. 

Mark:

That’s interesting.

Owain:

OK, guys – well, I think we’ll call it a day there.  I’m going to get it, I think, in the neck from Mark for my comments about Zumba and whatnot as soon as the recording stops, so if I never speak to you again, listeners, I’ve enjoyed doing these recordings. 

Mark:

You’ll know what’s happened to him!

Owain:

Exactly.  OK, see you, guys.

Mark:

Bye.

Nate:

See ya.

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