In a world where socialist and populist dictators can appear at any time, Swiss private banks represent a key civil liberty whereby people of even

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2 2 In a world where socialist and populist dictators can appear at any time, Swiss private banks represent a key civil liberty whereby people of even quite modest assets can preserve their wealth against state-sponsored looting.

3 There s a reason the world s most successful banks are based in Switzerland. Switzerland is home to the world s strongest currency. This is a huge advantage for banks because their capital goes up in value against other countries banks as the Swiss franc appreciates, making them progressively more powerful. Add to that Swiss banking secrecy laws, which protected German Jews during World War II, and you have the world s most powerful banking system. Many U.S.-based multinationals reported softer top and bottom lines, disappointing their shareholders. There is, however, one sector for which a strong base currency is very beneficial: banking. The Swiss franc is one of the world s strongest major currencies, having fluctuated around parity versus the U.S. dollar over the past five years. During this period the euro has declined 20% against the dollar, the yen has fallen 27%, and the British pound has lost 12%. The two biggest Swiss banks waste their time with investment banking. Our choice is the premier Swiss bank that concentrates on the Swiss banks prime business: private banking and fund management. The Truth about Franc Strength In general, a very strong currency is bad news for companies headquartered in its country. Costs related to manufacturing as well as staff and support functions go up. The value of exports decreases in the home currency, so revenues shrink. And profits are squeezed from two sides. We saw this dynamic play out for American companies in Even the Singapore dollar, the other leading private banking currency, has declined 7% against the US dollar. Money markets adjust for this strength. The sixmonth Swiss franc London Interbank Offered Rate (LIBOR) is negative 0.66%. The LIBOR is a daily reference rate based on 3

4 the interest rates at which banks offer to lend unsecured funds to other banks in the wholesale money market. As of this writing, the six-month U.S. dollar LIBOR is 0.90% and the British pound is 0.74%. The six-month Japanese yen LIBOR is 0.02%. And the euro is negative 0.13%. The six-month Singapore Interbank Offered Rate, the Asian equivalent of the LIBOR, is 1.31%. These interest rates show that the Swiss franc is expected to be as strong against all major currencies in the future as it s been in the recent past. A trader buying dollars six months forward for Swiss francs would receive a premium of about 0.7% against the current spot rate because of the arbitrage between currency and deposit markets. This gives a Swiss bank a major competitive advantage against its foreign competitors, particularly in this era of closely regulated capital. Because it s held in Swiss francs, its capital generally increases against its foreign competitors. Alternatively, its foreign currency assets decline in value against its Swiss franc capital. This tends to reduce leverage. And it gives it an advantage against foreign competitors in terms of taking on new customers and in putting more foreign currency business on its books. No. 3 Is the Magic Bank The two largest Swiss banks, UBS Group AG (UBS) and Credit Suisse Group AG (CS), negate some of this advantage by having big ambitions in global investment banking. Although the Swiss capital base is an advantage here too, being domiciled in a small country isn t beneficial. UBS and Credit Suisse lack the close client relationships enjoyed by the big U.S.-, Germany-, and Japan-based investment banks. In addition, investment banking itself is not an attractive business for shareholders. The big, up-front fees tend to walk out the door each year as bonuses. Meanwhile, the even larger fines for malfeasance occur years later, when all the malefactors have either left or retired and their bonuses have disappeared into luxury living. From an investor s perspective, the third-largest Swiss bank, Julius Baer Group AG ( JBAXY), is far more interesting. Tradition Lives Julius Baer doesn t harbor investment banking ambitions. It specializes in conventional banking, particularly private banking and asset management. 4

5 During the first six months of 2013, CHF6 billion in new money and good market performance was offset by a translation adjustment of over CHF20 billion. Total assets of the bank decreased from CHF82.2 billion to CHF80.1 billion. In other words, even though new money came in and assets increased, the overall increase in Swiss francs was negative. This reduced leverage on the bank s capital, which according to the Bank for International Settlements was a generous 20.1% of assets as of December 31, Julius Baer is an important player in asset management and private banking. Although it recently closed its operations in the U.S. because of heightened legal risk, its base in a strong country provides an important advantage in international expansion. In early 2015 it announced the intention to buy a minority stake in NSC Asesores, the largest wealth manager in Mexico. Management reported that Julius Baer s operating income grew by 6% in Earnings per share declined by 52% because of a provision related to cessation of U.S. operations. On December 31, 2015, management agreed to settle the bank s outstanding U.S. tax investigation for $547 million. Excluding that one-time item, earnings were up 20%. Julius Baer stock is trading at 12.9 times estimated 2016 earnings and is priced to yield 2.3%. Wealth Preserver In 2012 the bank bought the non-u.s. operations of Merrill Lynch, with $84 billion in assets under management, while in 2014 it bought the private banking assets of the Israeli Bank Leumi. Management s growth strategy centers on expanding the banks private banking and asset management base for emerging market clients. Julius Baer s strong currency capital base and 5

6 Switzerland s excellent reputation for private banking and client confidentiality support this strategy. Its two Swiss competitors, UBS and Credit Suisse, have both focused heavily on the volatile investment banking business, undermining their credit quality and creating the potential for numerous conflicts of interest. Julius Baer thus represents the largest pure asset management/private banking play in the Swiss space. Swiss banks have acquired a gamey reputation in the U.S. But in a world where socialist and populist dictators can appear at any time, Swiss, Singaporean, and other international private banks represent a key civil liberty whereby people of even quite modest assets can preserve their wealth against state-sponsored looting. This is a business that can only increase as governments debts become more unmanageable. And Julius Baer is well positioned to take advantage of the trend. Action to Take: Buy Julius Baer Group AG ( JBAXY) at market prices. 6

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