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Fund Manager Commentary As at 31 October 2022
Equity markets rose sharply in October, as the political crisis in the UK was resolved with surprising speed and investors took the view that central banks would at a minimum have to slow the pace of interest rate hikes, notwithstanding the fact that bond yields continued to rise over the month with the UK being one of the few exceptions. Against this background, the Trust’s net asset value rose 3.9%, lagging the rise in our benchmark, the MSCI ACWI Financials Index, which rose 4.5% (both in sterling terms), in part due to our overweight positions in Hong Kong and the UK, albeit the latter weakness was partly offset by the bounce in sterling.
US financials
US financials rose 8.9% in October with broad-based strength across banks, insurance and diversified financials. Banks reported solid third-quarter results which were supported by strong revenue growth due to the continued expansion of net interest margins. They also used the opportunity to increase loan loss reserves on a precautionary basis despite a further fall in the percentage of non-performing loans. Deposit betas remain lower than expected in aggregate, which is supportive, albeit there has been a wide dispersion on an individual bank basis with market scrutiny on those names seeing lower deposit balances or higher deposit costs, notably First Republic Bank, which we have subsequently sold.
Chubb and Arch Capital, our two largest property & casualty insurance holdings, both reported reassuring results during the month. While overshadowed by losses from Hurricane Ian, which hit headline numbers, underlying results led to earnings upgrades. There was further commentary during the month that reinsurance pricing needs to rise materially to factor in less retrocession capacity among other factors, which we see as supportive for the sector. Arch Capital also had a boost from its stock being added to the S&P 500 Index, effective from the beginning of November, which resulted in a jump in its share price.
Asian financials
Asian financials fell 2.7%. Against a more difficult macro environment and delays relaxing Covid-related measures in China, we have been gradually reducing our exposure to the region, selling our holdings in Chailease Holding and Bank of the Philippine Islands. Recent political developments in China have implied a more hard-line approach to Covid and Taiwan, the latter making it very difficult to invest in Taiwan. Exports have been weakening in Singapore, China, Taiwan and South Korea and there is a clear downturn in electronics/semiconductor exports. Other than Singapore, where we own DBS Group, we have no direct exposure to these markets, although we do have indirect exposure through holdings in Hong Kong and the UK, for example HSBC Holdings and Prudential which we have added to, the latter currently at a very attractive discount to its Asian peers.
Inflation has been rising throughout the region and this has resulted in interest rate hikes in a number of countries, notably Vietnam, Thailand, Indonesia, India, South Korea and Australia, prompted also by weak currencies in the face of the relentless rise in the US dollar. Having said that, unlike the Asian Financial Crisis, there is little evidence of an impact on asset quality as foreign currency lending is at much lower levels today than in the 1990s. India and Indonesia remain our principal exposures but valuations limit the ability to raise exposures further. We need to see a stronger domestic economy through retail sales/consumer spending, to raise exposures to Asia and add new holdings, but as yet, the picture remains very mixed.
European financials
European financials rose 5%, broadly in line with the sector, as weakness in the UK due to the political mess and a negative reaction to bank results was offset by strength elsewhere in the region. We are mid-way through the reporting season which has highlighted the significant tailwind to earnings from rising interest rates in the region – in aggregate, for the 18 banks to have reported, net interest income rose 26% y/y. The strength in core revenues has more than offset the rise in provisioning which was primarily driven by model adjustments to weaker economic forecasts with asset quality trends remaining benign and has led to small upgrades to consensus earnings forecasts.
During the month we made limited changes to our overall bank exposure in the region, with further reductions in our holding in OSB Group reflecting the deteriorating UK outlook offset through additions to DNB Bank and AIB Group which both reported solid third-quarter results, benefiting from a relatively resilient macro backdrop in Norway and Ireland and tailwinds from rising rates. We also increased our fixed income exposure, using the selloff to add to a number of subordinated bonds of banks and insurers, including Pension Insurance Corporation and Rothesay Life, at yields of between 8% and 12%.
Forty years ago a one-branch bank in Oklahoma City failed and in the process was the trigger for the collapse of Continental Illinois, the seventh largest bank in the US with around $40bn in assets. We wrote about it last month, explaining how bad underwriting, the rapid expansion of balance sheets and a reliance on wholesale funding as opposed to retail deposits was as toxic a combination then as it was in the global financial crisis. Today, neither are evident in the banking sector which augurs well for returns, notwithstanding the impossibility of predicting shorter-term moves in financial markets.
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