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CME GROUP: A HIGH-QUALITY
FINANCIAL EXCHANGE
Last year’s volatile markets presented us with opportunities to add high-quality businesses to our global equity portfolios. One that stands out is CME Group, which owns the Chicago Mercantile Exchange. In our view, the company has robust profitability, a track record of sustained earnings growth and formidable barriers to entry, all of which make it a compelling long-term investment.
As the world’s leading derivatives marketplace, CME Group enables clients to trade futures, options, cash and over-the-counter markets, optimise portfolios and analyse data – empowering market participants worldwide to efficiently manage risk and capture opportunities.
CME Group’s exchanges offer a wide range of global benchmark products spanning all major asset classes – based on interest rates, equity indices, foreign exchange, energy, agricultural products and metals. Its CME Globex platform facilitates futures and options trading, while BrokerTec handles fixed-income transactions and the EBS platform powers foreign exchange trading. In addition, it operates one of the world’s leading central counterparty clearing providers, CME Clearing.
We invested in CME Group in June 2024. As can be seen on the chart below, CME’s share price had remained stagnant for over five years while the earnings power had surged by more than 40%. We therefore paid only 19 times cash flow for this high-quality business.
CME is a high-quality company that has lagged the US market by no less than 80% over the past five years. With earnings improving markedly over the same period, CME’s valuation has now contracted to the point where it is trading more in line with the broader market.
Yet the company has demonstrated the ability to significantly outperform the average US stock over time in terms of earnings growth. Today investors are paying a valuation for CME similar to the overall market – but for a company of superior quality with a good balance sheet.
We have raised our concerns with CME’s management over why the share price has traded sideways for the past five years. Management believes contributors include the perception of a peak interest rate environment, more specifically the notion that the stock will benefit only in a rising rate environment, which leads investors to assume that derivative trading volumes may have already hit their high-water mark.
Interest rates are CME’s largest derivatives segment, accounting for over 50% of trading volumes and more than a third of its options and futures revenue. It would therefore be fair to say that US interest rate expectations and the US treasury market could have a significant impact on the outlook for this segment and CME’s overall business performance.
CME is challenging this narrative, pointing out that, despite it being 10 months since the last rate hike, rates volumes have still increased by 12% year on year over the past nine months. When you look at the past 25 years since markets digitised and compare US Federal Reserve rates with CME volumes, it’s clear that volumes come down – but every time this has happened, rates reached zero (or near-zero) and remained there. CME believes we haven’t witnessed a normal interest rate cycle in a long time – with inflation levels where they are, the current environment is fundamentally different.
CME complements our strategy of being invested in high-quality exchanges with similar barriers to entry. Alongside CME, both LSE Group and Intercontinental Exchange remain core holdings, having already delivered strong performance. These companies continue to generate durable, growing revenue streams that are protected by deep moats.
In conclusion, we expect CME’s strong volumes to persist, supported by an environment of higher rates, inflation and both geopolitical and macroeconomic risks. At current levels, we view the risk/reward profile as balanced, but upside slightly constrained until the debate around competition subsides.
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