It would not come as news to bank investors that the share prices of the Big 4 banks have well and truly entered correction territory compared to their recent highs.
The Australian market as a whole is overweight financials and financial services stocks, so when the Four Pillars tumble, it’s not surprising that the whole market wobbles. But Challenger Ltd (ASX: CGF) is a strong financial services stock that is not affected by many of the same headwinds as the banks, and that could be why it outperforms those stocks in the long term.
The core business of Challenger is selling annuities to those who are retired or soon to be retired. Unlike shares or property, annuities are a financial product that is far less sensitive to market fluctuations.
Instead, in exchange for an up-front investment, an annuity will pay out a regular income stream to the investor. Challenger does the “behind the scenes” work of taking the money from annuity sales, pooling it, and investing it in a way that guarantees future returns.
With low economic growth, record low term deposit rates, a volatile share market and overheated property market, it is not surprising that investors who want a stable retirement stream are flocking to annuities. In addition, a huge population bulge of baby boomers in Australia will soon leave the workforce, and will seek to diversify their investments to protect their hard saved capital from losses.
In Australia, statistics show that less than 5% of total retirement savings are invested in annuities. In other developed economies around the world, the level of investment in these same products is closer to 10% – 15%.
That is incredibly positive for a stock like Challenger, because it means that the organic opportunities for growth are strong. A business that can effectively harness a growing overall market for its products is one of the best kind of businesses to own, as it means that even by simply maintaining market share the business can grow its profits.
Favoured by planners
If you have not heard of annuities before, that’s alright, because financial planners have. In fact, nearly six out of every ten financial planners in a survey were planning on recommending that their clients invest at least part of their retirement savings in annuities in recent years.
Planners are key to Challenger’s business model as they are effectively the distributors of the products created by the company. Challenger is also diversifying its distribution channels, as shown by its deal to sell its products directly to VicSuper members.
Dominant market position
Among those same surveyed planners, Challenger clearly has a dominant brand and market position. In fact, over 80% of planners who were intending to recommend an annuity said that they would use, or had already used, a Challenger product.
That’s a little like the market share of cola drinks that Coke Cola would have if Pepsi suddenly disappeared from the shelves. And that would be an opportunity that would have people falling over themselves to invest in.
The way that Challenger actually delivers its guaranteed returns to annuity purchasers is a complex blend of statistics, portfolio construction, actuarial analysis and asset allocation, which means that potential competitors face high barriers to entry.
With the Big 4 banks exposed to downside risks including a potential property market bubble, an increase in unemployment or an increase in historically low bad debts, Challenger looks like a much better financial services exposure for investors with a long-term investment horizon.
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Motley Fool contributor Ry Padarath owns shares of Challenger Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.