Momentum reversed, financials rewarded - July Trust Update

Market review

Global equity markets were mixed in July. The MSCI All Country World Index fell over 1% in sterling terms, but there was a sharp rotation in market leadership beneath the surface. The technology sector was particularly weak as momentum reversed sharply in companies exposed to AI-related semiconductor capital investment. Tensions in the Middle East re-escalated, triggering a sharp rise in the oil price which briefly hit $100 per barrel, only to fall back towards $80 as markets eventually looked through this uncertainty. Against that background, the Financials sector performed strongly, continuing June’s positive momentum. The Trust’s net asset value (NAV) rose 3.0% during the month, behind 4.9% from its benchmark, the MSCI All Country World Financials Index.

Positive US bank results

US bank results were very strong, beating expectations, due to strong capital market activity and resilient credit performance. Trading and investment banking revenues rose sharply across the industry, with JP Morgan, Morgan Stanley and Goldman Sachs each reporting earnings significantly above forecasts largely due to equity trading revenues being much stronger than expected – up 86%, 69% and 72% over the year respectively. Bank of America and Citigroup also surprised positively. While there are understandable questions over the sustainability of trading revenues, management teams pointed to healthy mergers and acquisitions (M&A) pipelines expected to underpin further growth in investment banking revenues that are still below the most recent peak seen in 2021.

Outside capital markets business, and against the background of solid US economic data and employment trends, consumer spending remains resilient and delinquency trends broadly stable or improving. Banks’ need to strengthen ‘bad debt’ reserves remains modest despite persistent macroeconomic uncertainty. Easing regulation provides further support, with management teams increasingly optimistic about capital flexibility and future returns from proposed changes. The US banking sector therefore continues to offer the potential for further earnings growth, increasing shareholder returns and exposure to rising M&A activity.

Trading platforms and volatility

Elevated volatility remained a key positive for trading platforms in July. Activity was influenced by a sharp rotation in equity markets, continued geopolitical uncertainty and volatility around AI-related market leadership. However, IG Group Holdings (IG Group) and Plus500 both suffered sharp falls in their share prices and consequently were the biggest drag on performance during the month. This was despite both reporting solid results which had been preannounced and the historic conservatism both management teams have shown with respect to guiding the market on the outlook for earnings.

Both had benefited from a strong run up in their share prices ahead of results. IG Group raised forecasts and announced a strategic review. Plus500 had similarly raised guidance for profits and there was an expectation that it would see the benefit from partnerships it had recently signed to act as a clearing firm for prediction markets. But IG Group and Plus500’s shares both fell on the lack of further increases in guidance and, for Plus500, a weaker active customer number, which tends to be a very volatile figure. Meanwhile, IG Group’s acquisition of Underdog, a US sports betting and prediction market business, was poorly received by investors.

Prediction markets are platforms where people can buy and sell contracts tied to an event, whether that is a sports event, an election or a financial market outcome. Polymarket and Kalshi, both private companies, dominate the market, with Underdog a distant third – although it gives IG Group an option on the growth of the industry. However, there remains regulatory uncertainty over prediction markets. Their regulation by the Commodity Futures Trading Commission (CFTC) is at odds with the vast majority of US states which have historically regulated and taxed sports betting. This has led to legal action that is expected to be resolved only once it is referred to the US Supreme Court.

We had reduced our holding in IG Group following its strong share price performance and have reduced it further subsequently on concern that the extended period of uncertainty could lead to its share price treading water until there is greater clarity. Nevertheless, we do see the merits of the acquisition in diversifying IG Group’s business in a potentially very fast growth area and the structuring of the deal with management remuneration mostly tied to success of the business in 2029 and 2030. Conversely, we have added to our holding in Plus500 feeling that the balance of risk and reward is more favourable.

More developments in Italian M&A

Italian banking consolidation remains one of the most active themes in European financials. Banca Monte dei Paschi di Siena (MPS), the world’s oldest bank, has been subject to a bid from Intesa Sanpaolo, Italy’s largest bank, and, separately, merger proposals with Banco BPM, the fifth largest bank in Italy. However, the latter withdrew its interest citing a lack of progress as well as opposition from its largest shareholder, Credit Agricole, which could not see the strategic value in a tie-up. Such a merger would have had broader implications for the structure of the Italian banking system.

We are exposed to this transaction through our holding in BPER Banca (BPER) which we believe stands to benefit because Intesa Sanpaolo’s bid involves BPER’s largest shareholder, Unipol, an insurance company, taking part in the transaction. The transaction would result in a transfer of a substantial number of MPS’s branch network to BPER, which would in turn benefit from material earnings accretion and become the second-largest lender in Italy. Although the outcome remains uncertain, the level of activity highlights the increasing strategic value of scale in Italian banking. We continue to believe the market underappreciates the value creation potential from M&A in Italy and beyond.

Outlook

Recent results have again shown the favourable fundamentals that underpin our constructive outlook for the sector and have led to further positive earnings revisions. We believe more normalised interest rates, a widening between short- and long-term borrowing rates and an easing in regulation, as governments shift to a more pro-growth stance, provide a supportive environment. With sector valuations still undemanding in both absolute and relative terms, we retain a balanced approach to portfolio construction, favouring the earnings resilience and capital strength demonstrated through the reporting season.