Market review

Financial markets rallied sharply in November, albeit partly offset by US dollar weakness, as inflation pressures eased across both sides of the Atlantic and Fed officials signalled their “increasing confidence” that interest rates had peaked. Against this background, the Trust’s net asset value rose 4.2%, while its benchmark, the MSCI ACWI Financials Index, rose 5.6%, with the lag due to our overweight position in the property and casualty insurance sector where profit-taking led to lower share prices in the likes of Arch Capital and RenaissanceRe Holdings.

US financials rose over 7.5% in the month, led by banks and diversified financials as concerns around the economic outlook eased. October PCE data (the Fed’s preferred measure of inflation) was flat versus the previous month with Fed Governor Christopher Waller noting the possibility of a rate cut in the coming months should current trends continue. Feedback from bank managements at conferences during the month highlighted an expectation that deposit costs are beginning to stabilise while loan books are repricing up, suggesting net interest margins could inflect higher in the second half of 2024.

Asset quality is expected to weaken from here, albeit banks are not seeing meaningful deterioration to date, with losses in commercial real estate expected to be mitigated by low loan-to-value and geographical diversity. Nevertheless, Citizens Financial Group highlighted its conservatism in its office commercial real estate book where it has already assumed defaults of one in every five loans and a write-down of 50% on each loan that defaults. If this analysis were extended to the wider regional bank sector, the impact on earnings would only be around 10% of fourth quarter earnings.

European financials also saw strong gains during the month, rising by 7.2%. While ECB President Christine Lagarde stated that the fight to contain inflation was not yet done, market expectations have increased for earlier and deeper interest rate cuts following data showing a moderation in inflation (core inflation in the euro area fell to 3.6% in November, the lowest reading since April 2022). Payment companies saw a strong recovery during the month with Adyen’s analyst day alleviating some concerns and supporting broader sentiment in the subsector.

Asian financials significantly lagged the rally in financial markets, as the release of mixed economic data on China weighed on the market which continued its underperformance in November. While China has announced additional stimulus, there are doubts as to the fiscal room available as well as longer-term questions as to the ability of the government to shift from an investment-led to consumption model at a time when consumer confidence is affected by a protracted slump in the real estate sector. In contrast, India’s economic trends remain robust and GDP growth came in ahead of expectations, up 7.6% year-on-year, albeit supported by a front-loading of government spending.

AT1 market

Debt markets were very strong in November on the back of softer inflation prints, resulting in a pick-up in issuance of AT1 bonds. UBS issued $3.5bn of AT1 bonds priced at 9.25%. A number of debt investors who had publicly stated they would never buy another Swiss bank AT1 bond after the actions of Swiss regulators to write down Credit Suisse AT1 bonds to zero in March, were reportedly buyers of the bonds, leading them to be nicknamed ‘Dory bonds’ by Financial Times Alphaville, after the name of the fish in the film Finding Nemo with short-term memory problems.

Debt markets were very strong in November on the back of softer inflation prints, resulting in a pick-up in issuance of AT1 bonds. UBS issued $3.5bn of AT1 bonds priced at 9.25%.

The Swiss regulator’s ability to act with impunity is writ large in the prospectus which states that, “FINMA has the power to [order] Protective Measures before a Trigger Event or a Viability Event has occurred”. For “protective measures” here, read ‘write-down of AT1s’. Respect of the creditor hierarchy is also unclear, with the prospectus stating that in the event of a restructuring, noteholders “will not (i) receive ordinary shares…or (ii) be entitled to any subsequent write-up or any other compensation…while shareholders of the issuer may be entitled to compensation in accordance with [Swiss Law]”.


We highlighted in last month’s commentary that with valuations having fallen to similar levels seen during the Eurozone crisis, 2016 and 2020 – which were all great opportunities to be adding to the sector – we had selectively added to our US bank holdings, taking us overweight having been underweight relative to our benchmark. In particular, with 2023 being arguably the worst year for relative performance of US banks for over 80 years and worse than during the global financial crisis, we felt they were mispriced.

Against that backdrop, we also added to a number of other holdings during the month, to increase risk, believing the rally in financial markets could have legs. This included starting a holding in BlackRock which we see as well positioned to benefit from a recovery in flows across the industry but would also be a beneficiary of what they have described as the “great reallocation” if flows into bond funds continue. Finally, we purchased some short-dated call options on a basket of US regional banks at a very small cost. As a result, gearing on the Trust rose over the month to around 6.5%.

Barely a month later in what has been described as an “everything rally”, we would not be surprised to see some form of correction or consolidation in financial markets in the short term. Undoubtedly, the good news of better inflation data increases the possibility of a softer landing for economies as central banks will have greater leeway to cut interest rates. However, given limited examples of central banks achieving a durable soft landing with only one achieved in the US post-World War II, we expect continued volatility, particularly with broader markets closing in on all-time highs. Either way we feel very constructive on the outlook for the sector.