Drawing on the Orbis Global Balanced Fund's long-standing investment in the Irish banks, Alec Cutler from our offshore partner, Orbis, illustrates how fundamental research and disciplined portfolio management can uncover opportunities obscured by market sentiment and short-term noise.
When news is buzzy, it is tempting to follow every last headline. As analysts, however, we spend most of our time on narrower, longer-term things. Our decade-long experience with the Irish banks is an excellent example of how we work.
The Irish banks
In the early 2000s, the Irish banking sector boomed. Real estate was thriving, and lenders eagerly fuelled development and buy-to-let activity.
That ended in tears during the global financial crisis (GFC). Housing prices tanked, defaults ballooned, and the Irish government bailed out the two local "pillar" banks, Bank of Ireland (BoI) and AIB Group (AIB), nationalising the latter in 2010. This made the banks deeply unpopular in Ireland. They had crashed the economy, caused people to lose their jobs and homes, and then been bailed out at taxpayer expense. Politicians, regulators and the public all treated the banks as villains.
Counterintuitively, this sowed the seeds of the banks' eventual recovery. When we analysed BoI and AIB in 2016, competition had dried up as foreign banks exited the market and smaller local ones suffered from mistrust without implicit state backing. By mid-2016, BoI and AIB together controlled over half of Ireland's retail deposits and mortgage lending.
For a bank, retail deposits are usually the cheapest source of funding, allowing banks to lend at the same rate as peers or at lower rates to grow market share. In happy times, this leads to rising valuations from approving equity investors.
These were not yet happy times, however. The Euro crisis was still playing out, the government still owned stakes in the banks, and regulators forced banks to hold more capital, tighten lending standards and bar payment of dividends.
That hardly sounds like a bullish investment case. But we have written before that tight regulation is like altitude training. It limits performance during the training but forces discipline and efficiency that allow better performance down the line.
At the time of our initial research, BoI traded below tangible book value, the key valuation metric for any bank. If a company can earn adequate returns on equity, it should trade for 1.0 times book value. So, with BoI trading at a discount, the market was effectively saying that it could not earn acceptable returns. We disagreed.
Ireland was becoming a concentrated market, where a few dominant banks could generate strong returns on equity and enjoy higher valuations. The GFC and Euro crisis had killed most competition, while regulatory pressure pushed the banks towards better efficiency and risk management. In the Orbis Global Balanced Fund, we first built a position in BoI in 2016, keeping an eye on AIB as the government started to offload its shares.
Purchasing the shares did not end our research process. Over the past decade, three Orbis analysts have researched BoI and AIB in depth, covering them throughout our holding period, and we formally reviewed our thesis in 2019 and again in 2024. This deep understanding served us well during the COVID-19 crash of 2020, an especially scary time for banks, which depend on confidence. We retained confidence in the Irish banks: They held more capital than required, underwrote conservatively, and with only two major industry players, depositors had limited alternatives. As the banks' valuations cratered to well below 0.5 times book value, we built a position in AIB and nearly doubled our BoI holdings.
Profits and valuations recovered as lockdowns receded, and the banks received permission to resume dividends. We trimmed our positions in early 2023, with valuations near book value, to fund more attractive ideas elsewhere.
Banks were tested again a few months later, a result of the global rise in interest rates and bond yields. Government bonds are a big chunk of most banks' balance sheets, and when bond yields rise, their prices fall. That impairs balance sheets, weakens confidence and threatens bank runs and insolvency. While this pressure claimed a number of banks in the United States and Europe, the Irish banks ploughed through unscathed, reaping the rewards of their prior altitude training.
Since 2023, BoI and AIB have thrived – growing profits and dividends. From lows of €2-3 per share, the share prices of BoI and AIB rose to €10-15. As the discount to our estimate of intrinsic value narrowed, we sold down the Fund’s positions over the past year.
What really mattered
The Irish banks illustrate a few aspects of our approach especially well. Firstly, don't get sucked into the day-to-day noise; throughout the past decade, there have been countless scary headlines about banks, most of which ultimately didn't matter to BoI and AIB's fundamentals.
Secondly, good news doesn't always sound like good news. For the Irish banks, the post-GFC regulatory clampdown was no fun at the time, but that altitude training sowed the seeds of the good times that followed.
Thirdly, focusing on individual companies is fruitful. Global banks have some fundamental drivers in common, but idiosyncrasies matter. It mattered that BoI and AIB essentially emerged into a duopoly, with high market share and low funding costs far more important to their fundamentals than most of the noise in news headlines.
Finally, risk management is essential. Our ideas do not always play out this well.
Long-term, nearly half of our picks end up underperforming, so taking our lumps in losers is as important as taking our profits in winners. With the Irish banks, we didn't try to time the bottom, but accumulated and trimmed over time.
Today is an exciting time for markets and the world economy, and exciting times make for exciting headlines. As analysts, we prefer to focus more patiently and more narrowly on the fundamentals of individual companies. Bottom-up security selection has driven the bulk of the Fund's relative returns to date, and we work hard to ensure those relative returns are good ones.