Synchrony Financial

Synchrony Financial (NYSE: SYF) is General Electric's former retail finance arm and presents an interesting opportunity to invest in banking/lending and private label credit cards. What first got me interested is its cheap valuation (<10 times ttm earnings) and high returns on equity/assets (30%+/3%). As a bank these are fantastic metrics, though leverage is normal.

But how is this as a business? SYF is a bank which uses its deposits/capital to lend to consumers often through private label credit cards. These are the Home Depot credit cards, etc. which are often pitched in checkout lines. The benefit to consumers are discounts (up to 5%) at that particular chain, while companies get another tool to offer brand loyalty and promotions. It is this last aspect which is useful for companies and may indeed give it some pricing power. As the largest private label credit card issuer by market share (40%+) it may indeed be the go to source for private label credit. It can therefore focus more on relationships than pricing.

However, the relatively high rates and typically lower-class clientele on consumer side may be difficult. In particular, there may be a saturation point for such credit cards because such cards are more useful at larger/diverse retailers such as Amazon.

This may indeed be one of the larger risks for SYF. Lending, while muted, is highly profitable now because lower overall interest rates are suppressing defaults and the danger is that the credit cycle is a peak. I believe this is less likely given the lack of lending overall by banks (i.e. monetary velocity) such that only the top borrowers are getting credit. SYF survived the last crisis while remaining profitable (per their prospectus), so at ~ 10 times earnings this looks to be a good price for a decent business.

Disclosure: Long SYF

Asset Allocation does Not Solve the Funding Gap

Many pension funds/endowments and many other defined-benefit plans are behind their benchmarks. 2013 helped greatly, though it was only in 2012 that funds where in big trouble. Basically, they have promised a certain amount of future payouts but their current funds are not enough to do so. Part of this reason is the Federal Reserve's QE and other rate-lowering methods. Plans can plan on 5% return from their treasury bond portfolios, but with 10-yr treasuries yielding less than 3% they fall short.

To solve this problem, investors have shifted out into the risk-curve, buying assets/funds with fewer guarantees at only marginally better yields. Is this the right call?

To answer, let's ask this: if buying higher yielding assets gets better results, why were funds just buying now? Why were they not buying in 2009/2010 when yields were substantially higher?

One answer: it's the incentives. Buying a higher yield now gives the possibility of hitting the target while pulling back guarantees under-performance. Liquidity/Fed and price-stability gives the illusion that all is good so that managers can do so. We already know the results of this; a similar bid occurred from 2001-2008 with CDOs and other yield-oriented instruments. We see that now in anything related to fixed income from MLPs (oil/gas etc.), mortgage reits, high yield bonds and of course alternative investments.

(Source: http://dealbook.nytimes.com/2014/08/14/the-signals-from-the-high-yield-bond-market/?_php=true&_type=blogs&_r=0)

The result? So far, pensions are better but it's despite their asset allocations. In the previous link, Rhode Island pension funds allocated to alternatives only to see vanilla equities outperform.

My point is that allocations should be driven by opportunities in the market, not trying to beat the benchmark every year. Just because the plan needs 5% returns does not mean one should choose the best-performing assets or those which yield the most. Investing is investing, that is, putting capital where the risk is (far) justified by the reward. Hedge funds/alternatives, bonds, equities should be judged on whether the manager/asset is priced relative to the risks they take. For example, right now activist hedge funds have been doing extremely well. Does this mean endowments should allocate more? Not unless they can get the top managers and lower-than-average fees.

Now, measuring risk/reward is a tough topic, to say the least. However, that should be the base for allocations. Using "alternatives" to "diversify" because the manager is scared of another 2008 is not. Investing in an equity manager/index when equities are cheap relative to norms; that is better.