Equity markets suffered significant volatility in August due to the trade war between the US and China, political events in the UK, Italy and Brazil and the continued demonstrations and riots in Hong Kong, all affecting sentiment. Against this background financials underperformed broad equity markets. The Trust’s net asset value fell by 4.3%, lagging our benchmark index because of our underweight exposure to REITs.

US and European bank stocks were particularly weak over the month, with our holdings in Bank of America, JPMorgan and SVB Financial Group the biggest negative contributors. Conversely our REIT holdings performed well. In particular, Mapletree Commercial Trust, one of our Singapore REIT holdings, saw a double-digit rise in its share price. Mastercard, the payments company, was also a strong contributor.

US banks came under pressure as markets priced in the expectation of further interest rate cuts by the Federal Reserve with the implied probability of a cut at the Fed’s September meeting rising to 100% from 62% in July. Growth in the US economy has slowed as the stimulus from tax cuts has faded but remains supported by a resilient labour market with consumer spending rising to an annual rate of 4.7%. Consequently, the data highlights the self-inflicted nature of the slowdown with geopolitics depressing business sentiment while other indicators (wage growth, labour market, M1, real interest rates) do not point to a recession.

Similarly, European banks remained under pressure in August with macro data highlighting the extent to which the region is exposed to the US/China trade war while Brexit uncertainty remains an overhang. The slowdown in German growth has increased expectation of fiscal stimulus and the European Central Bank (ECB) is expected to announce a stimulus package at its September meeting, potentially alongside deposit tiering (which would reduce what banks pay the ECB on surplus deposits) although the positive impact of the latter would be quite small.

During the month we visited Jakarta to get an update from company management teams. Overall our visit was positive although not suggesting a significant acceleration in growth (after a weaker first half of the year due to the Indonesian general election), at least not until certain commodity prices and global sentiment has improved. There has been limited impact from the trade war since it is not a large manufacturing exporter. Liquidity has been tight although recent cuts in interest rates and reserve requirements are helping to ease some of the pressure. Further cuts are expected.

Bank net interest margins have ticked up but cuts in interest rates will start to pressure them going forwards. Asset quality remains good and Bank Central Asia, which we hold in the Trust, noted there was little evidence of a deterioration other than a slight rise in special mention loans. Deposit growth has lagged loan growth so access to deposits will remain a key competitive advantage which is why we like Bank Central Asia, due to its strong position in payments and a loan/deposit ratio which is well below the average for the sector.

We added to holdings in DNB, Norway’s largest bank and Bank of the Philippine Islands during the month. We also reduced the Trust’s US bank exposure with the sale of our holding in Pacific Premier Bancorp, a Californian bank. Other holdings that were reduced in August included Fortune REIT, a Hong Kong shopping mall-focused REIT, VPC Specialty Lending Investments and BOC Hong Kong.

At the time of writing European banks are hitting 50-year relative lows (no doubt Japanese banks are not that dissimilar). Valuations have reverted to the crisis level lows of 2009, 2012 and 2016. On a price to book basis that equates to 0.6x and on a P/E ratio they are at 7.7x (their P/E ratios are lower than the lows in 2009 and 2016). For eurozone banks (stripping out the UK, Nordic and Swiss banks) the multiples are even lower.

Elsewhere valuations in bank shares remain depressed, insurance stocks appear reasonably valued and REITs, where we have reduced exposure, continue to see their valuations rise benefiting from the fall in bond yields (some retail REITs and more recently Hong Kong REITs have performed poorly). We have pulled back our exposure to banks over the past six months, increasing exposure to insurance and payments companies but when the macro outlook improves banks will not stay at these historically depressed levels and we remain well positioned to take advantage of a change in sentiment when it happens.

06 September 2019

Nick Brind

Fund Manager

John Yakas

Fund Manager