If you follow politics, then you've probably heard of Mick Mulvaney, a key member of President Donald Trump's administration. Mulvaney ran the Office of Management and Budget from February 2017 to March 2020. During that time, he also served as acting director of Consumer Financial Protection Bureau (CFPB) and acting White House chief of staff. He left that last role in March, and is currently the U.S. special envoy to Northern Ireland.
But Mulvaney has also taken on a new role. He is partnering with Andrew Wessel, a previous portfolio manager at Sterling Capital Management who focuses on the financial sector, to launch a new financials-focused fund called Exegis Capital. On a recent S&P Global Street Talk podcast, Wessel described Exegis as a fund "looking to take advantage of changes in regulation and legislation impacting the financial services industry both long and short." Let's dig into this investment strategy.
Mulvaney said on Street Talk that his tenure in Washington has led him to believe that the market is no longer being influenced by fundamentals, but is much more dependent on regulation, a revelation unmasked by the coronavirus pandemic.
This is something that investors interested in the financial sector should certainly keep in mind. With so much going on since the pandemic hit, it is easy to forget that the financial services sector is one of the most, if not the most, heavily regulated industries. Banks and insurance companies must hold regulatory capital to guard against unexpected losses. There's also all sorts of reporting and licensing requirements for most financial companies.
I think Mulvaney's point is even more relevant right now when you consider that many financial stocks, particularly those that issue loans to consumers, are even more dependent on regulation than normal. For instance, government intervention early on in the pandemic such as $1,200 stimulus checks, the Paycheck Protection Program, and enhanced unemployment benefits have helped prevent borrowers from going into default right away.
Now, many in the industry are watching to see if Congress will pass another bill with enhanced unemployment benefits, and at what level those benefits will be at. The hope is that government intervention can bridge people back to unemployment. If this pans out, banks, credit card companies, and other lenders may see more of their current loan deferrals come back into good standing.
Then there's the upcoming presidential election. "It's going to work a certain way under a Biden administration and I think we understand how that works. It would work a different way under a second term of a Trump administration and I know how that works," said Mulvaney.
While the financial sector is not a focus of either presidential candidate's campaign, Biden has made it clear that he would do certain things like increase the corporate tax rate, and look to increase the capital gains tax rate as well. He could also implement politicians like Sen. Elizabeth Warren into his cabinet or administration that would look to more heavily regulate the industry.
So, a Biden presidency sets up some potential short plays on financials, depending on where they are trading at the time. But the other side of the equation is four more years of Trump could continue a tense relationship with China that could create more volatility and uncertainty in the market than a Biden presidency would. Because banks are so closely linked to the economy, this could impact them adversely as well, so there is a lot to keep track right now and consider as you go to invest.
Looking where there is less regulation
It is perhaps this reason that Wessel says he does not foresee traditional bank stocks being a major focus of the fund. Rather, he said he sees a lot of opportunity in technology companies in the financials sector such as Duck Creek Technologies (DCT).
Duck Creek, a software-as-a-service company that sells its core systems to some of the largest property and casualty insurance companies in the country, kicked off its initial planned offering in mid August, and saw its stock surge right away. The first trade was made at $42 per share after the IPO was priced at $27 per share . Currently, the stock is trading at more than $37 per share.
Not only have many of these companies created technology that is easier, in many cases, for financial firms to buy instead of creating on their own, these companies also aren't regulated as heavily yet because financial technology is still new territory. "I don't think Washington has caught up to crypto, caught up to blockchain; caught up to fintech, and how those industries mature is one of the things we will be watching very closely," said Mulvaney. "I do think that as those paces mature, how Washington interacts with them is going to be very interesting and provide opportunities for folks who understand how those two things will react."
The majority of fintech regulation is still being crafted. Many states have different fintech laws, and there is constant legal battles between the state and federal regulators regarding licensing requirements for fintech companies. Various regulators are also experimenting with fintech sandboxes, which essentially allows a fintech company to test their product or service without doing a full launch. How regulators treat fintech companies will certainly have an impact on fintech stock prices.
What does all of this mean?
In a sector like financials, Mulvaney and Wessel certainly reinforce the fact that regulation cannot be ignored. There is money to be made if you can understand what regulation may be coming in the future and how it will impact the company you are looking at. Additionally, the fintech sector offers some really good opportunities right now, but the sector may not be like this forever. So, as Mulvaney suggested, watching Congress, the regulatory agencies, and the presidential election is very important right now, and retail investors need to keep this in mind when evaluating financial stocks to invest in.