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Fund Manager Commentary As at 31 August 2022
Financials markets fell in August as a rally on lower-than-expected July US inflation and better-than-expected jobs data gave way to weakness by month-end, as Fed Chair Jerome Powell reiterated the Fed’s commitment to restoring price stability in a hawkish speech at Jackson Hole. Sterling fell, offsetting the falls in equity markets with the result that the Trust’s net asset value rose 3.1%, while our benchmark index, the MSCI ACWI Financials Index, rose 2.5%. The outperformance was due to our holdings in Asia and UK non-life insurance holdings, partly offset by weakness in payment companies and an underweight in Latin America.
US financials
Against this background, US financials were relatively resilient, rising 2.7% over the month. Powell’s remarks reinforced the perception that they were committed to reducing inflation and willing to slow growth in order to achieve it. References to the longer-run policy outlook signalled the Fed’s willingness to keep rates higher for longer with front-end rates rising and building in an increased probability of a 75bps hike next month. While the Fed’s preferred measure of inflation (core PCE) eased in July (4.6%), largely reflecting a fall in petrol prices, it remains well in excess of their comfort level and data pointed to sustained tightness in the labour market.
Data released in August highlighted solid asset quality trends at US banks (delinquencies -5bps q/q to 1.19%, an all-time low) but the increase in early-stage delinquencies at certain sub-prime lenders where the Trust has no exposure could signal a broader weakening in asset quality, from the current very benign levels. We are confident in our US bank holdings’ ability to weather a weaker macro environment given balance sheet strength and an absence of a lending boom, and loosening credit controls, which typically precedes a turn in the cycle. However, in light of increased macro risks, we reduced exposure to certain bank holdings, primarily SMID cap, during the month.
Asian financials
Asian financials rose 3.7% in August. Although the overall macro environment remains resilient there are a few signs of pressures ahead with exports plateauing in number of countries, primarily those reliant on semiconductors or China-related exports with north Asia most likely to be impacted. Commodity exporting countries such as Indonesia and Malaysia have seen more resilient export trends although the fall in freight rates globally is not a good omen for exports from the region (i.e., less demand from the west). Inflation is edging higher and most countries are continuing the path of raising interest rates although there is as yet little impact on domestic consumption.
As in Europe, tourism is recovering strongly in those markets with few Covid restrictions (such as Thailand and Vietnam) and remittance inflows are also recovering (from offshore labour, a particular benefit for the Philippines) which, together with strong commodity prices, is helping to offset some of the pressures of the strong dollar. China remains the principal concern although the weak domestic economy will be helped by recent government stimulus measures – going against the trend, China cut interest rates during the month. Our preferred markets from a macro perspective remain India, Indonesia and Vietnam.
The Asian bank results season was also reasonable with net interest margins rising in most countries. There is little pressure on asset quality and most sectors are going into a potential global downturn well reserved and with strong capital positions. China and Hong Kong have been the exceptions, with the former seeing pressure on margins and the latter having weak loan demand and upward pressures on non-performing loans, albeit from very low levels, as Covid restrictions continue to impact domestic economies.
Valuations are undemanding except in our three preferred markets of India, Indonesia and Vietnam, which limits our room to raise exposure further. Equally, there are fewer of the concerns which have driven a reduction in our bank exposure in the US and Europe due to the severe energy-related pressures on consumers – most Asian markets have always been more proactive in managing energy prices to the consumer – or asset quality worries so far.
European financials
European financials underperformed over the month, rising by 1.1%, affected by FX movements with sterling seeing particular pressure, as highlighted above. The region has seen relatively large downgrades to consensus growth estimates (Eurozone 2023 GDP -170bps ytd to 0.8%) affected by rising gas prices with the euro’s annual energy import costs increasing to €800bn (6.4% of GDP) compared to €200bn (1.6% of GDP) in 1Q22. While European gas storage levels have risen ahead of targets, the region is still exposed to a complete halt of Russian gas supply which could necessitate energy rationing and a more pronounced slowdown in economic activity.
European banks reported solid second quarter results, which, along with higher interest rate expectations, led to earnings upgrades on the back of higher net interest income, which has more than offset higher provisioning expectations. However, in light of Europe’s vulnerability to the energy crisis, we have taken a more cautious approach and have reduced our exposure to the region, notwithstanding there is the potential for greater government intervention to mitigate the impact on the consumer.
Outlook
Looking forward we remain very constructive on the outlook for the sector on any meaningful timeframe, with valuations towards the bottom end of their post-global financial crisis historical range. For example, using 2023 estimates, banks now trade on a 7.9x price to earnings ratio while insurers are on 9.8x, both well below the 14.7x that global equity markets are valued at using MSCI data. Nevertheless, we have reduced the Trust’s gearing in expectation of continued volatility in the shorter term and wait for an improvement in the outlook before adding risk again.
Nick Brind
Nick’s experience comes from running specialist and generalist funds with UK and global mandates for the past 25+ years
John Yakas
John was an investment banker and Head of Asian Research, in London and Hong Kong, before joining Polar Capital in 2010
George Barrow
George is a specialist financials fund manager as well as an analyst across Europe, Asia and emerging markets
Historical Fact Sheets