Financials outperformed in September as hawkish central bank action triggered the sharpest rise in bond yields since March with the US 10-year hitting 1.5% from 1.3% while there was more dramatic rise in the UK 10-year yield rising to 1.0% from 0.7%. Despite equity markets falling, this was offset by sterling weakness resulting in positive performance during the month. As a result, the Trust’s net asset value rose 1.7%, while our benchmark index, the MSCI ACWI Financials Index, rose by 0.6%.

Following a relatively balanced annual symposium at Jackson Hole in August, the Fed became increasingly hawkish in September, with half the 18 committee members now expecting a first interest rate rise in 2022 compared to seven in June. Fed Chair Jerome Powell also declared that tapering “may soon be warranted”, as the thresholds (maximum employment and price stability) have been “all but met”, and that, once started, it could be concluded by mid-2022 – faster than initially expected.

This was echoed across the Atlantic, with the Norwegian central bank raising interest rates by 25 basis points, and the Bank of England (BoE) noting that developments since the August Monetary Policy Report had “strengthened” their view that monetary policy will have to be tightened over the forecast period. This was confirmed by the Governor of the BoE in a speech to the Society of Professional Economists at the end of the month. In total, 12 central banks raised interest rates in September – the largest in a single month in just over a decade.

European banks were much stronger in September, benefiting from the pick-up in government bond yields and a rotation into cyclicals during the month.

Crucially, these actions have been driven by further elevated inflation prints and growing signs that the pick-up in inflation is lasting longer than initially anticipated. Underpinning this is the continued rise in energy prices as demand has outstripped supply with commodity prices up by over 40% since the end of 2019 before the pandemic hit adding to the list of worries that investors face in the short term on the back of the sharp rebound in growth over the past year.

Against this background, US banks have underperformed wider equity markets since May, albeit this reversed sharply in September. With corporate and household balance sheets in a strong position as the economy reopens, we view supportive conditions for a pick-up in loan demand as early indications are positive with unfunded commitments to corporates up 22% year on year, while an upward move in interest rates would provide a significant tailwind to earnings. With valuations remaining attractive, US banks look well positioned and we continued to add to our holdings during the month.

European banks were much stronger in September, benefiting from the pick-up in government bond yields and a rotation into cyclicals during the month. Sentiment towards the sector was also supported by the removal of capital return restrictions with a number of banks announcing buybacks and dividends. For example, Nordea Bank, which is held in the Trust, announced a catch-up dividend equating to a dividend yield of 6.4% and a €2bn buyback to begin after third quarter results, 4.5% of its market cap. Given excess capital levels, improved visibility on the asset quality outlook and low levels of loan growth, we expect a number of European banks to sustain a high yield (>7%) in future years which we expect to continue to support their share prices.

Asian financials were relatively resilient during the month but included mixed trends, with continued weakness in China and Hong Kong as sentiment was affected by weaker macro data, sustained regulatory tightening and concerns related to liquidity risks within the property sector. While Evergrande presents risks to Chinese banks with exposure, as well as spillover risk to other leveraged developers, recent actions by China’s central and local government points to an orderly resolution and broader systemic risk could be supported by policy easing following an extended period of tightening.

As we look forward into 2022 it is likely the narrative will shift in the expectation that pent-up demand will continue to drive growth.

More broadly in the region, we are seeing some improvements in mobility trends and collection efficiency as COVID-19 cases decrease and restrictions are eased. The Fund is underweight China with no exposure to the banking sector. Following a material derating we have added to our holding in Ping An Insurance, a Chinese financial conglomerate with a strong life insurance franchise that is now trading at a record low P/E multiple and offers strong recovery potential. During the month, we also added to our exposure in Thailand and Indonesia through additions to existing positions and through the start of a new holding in Bank Rakyat Indonesia, a micro-finance lender where profitability should benefit from an acceleration in growth, provision normalisation and synergies related to recent acquisitions.

Financial markets have been hit by a number of factors in recent weeks, but as we look forward into 2022 it is likely the narrative will shift in the expectation that pent-up demand will continue to drive growth, while concerns around supply chains and shortages etc will start to lapse. Consequently we still feel very constructive on the portfolio. Absolute valuations remain low, relative valuations even more so as investors are only just starting to price in the improving outlook for interest rates while positive earnings revisions and the removal of restrictions on capital return should all underpin the pick-up in relative performance.