In August, equity markets continued to rally on the back of improving economic data as well as optimism that additional government stimulus and positive news on the development of vaccines would support the continued recovery in the global economy. Against this background, financials marginally lagged the rally and the Trust’s net asset value rose by 4.2%, while our benchmark index, the MSCI ACWI Financials Index, rose by 4.0%.

The biggest contributors to relative performance were Mastercard, the payments company, One Savings Bank, a UK-focused buy-to-let lender and SVB Financial Group, a US bank focused on the technology sector. Conversely, holdings in Marsh & McLennan, insurance broker, Chubb, a property and casualty company, and Keppel DC REIT, a Singaporean listed REIT focused on data centres were weaker over the month.

US financials rose 3.3% in August with the banking sector performing in line while insurers, including the likes of Chubb highlighted above, lagging on concerns regarding potential catastrophe losses from an active hurricane season. Economic data pointed to a continued rebound in activity with new home sales above pre-COVID-19 levels, real consumer spending continuing to rise while the July jobs report with 1.8 million+ jobs added came ahead of expectations. However, with government support set to fade, Congressional approval for the next economic stimulus program will be key in determining the shape of the recovery.

The announcement that the Fed has shifted its monetary policy strategy towards average inflation targeting, while largely expected, represents a significant departure in central bank thinking and implies sustained loose monetary policy in the short term and a greater tolerance for inflation to overshoot its target level. It also implies that interest rates will have to rise by more than expected at some future point which has led to the yield curve steepening.

Not surprisingly, investors remain sceptical about the Fed’s ability to achieve its target inflation level. However, the key difference today compared to the global financial crisis (GFC) is that policymakers’ response to the crisis has resulted in a jump in broad money growth, due to the direct transfers to consumers etc., raising the risk of higher inflation. While a shift to a more inflationary environment would be positive for the sector, we view provision normalisation, with banks guiding for loan losses to have peaked in the first half, as the near-term catalyst for a recovery in bank stocks.

European financials outperformed in August, supported by stronger economic data but also benefiting from dollar weakness. Despite evidence of an increase in infection rates across the region, governments have resisted re-imposing widespread lockdowns. German labour market data and business surveys came in ahead of expectations, leading the German government to forecast a smaller contraction of 5.8% in 2020 versus an earlier forecast of 6.3%.

One Savings Bank’s results were better than expected with a very strong level of capital, in part reflecting that they voluntarily suspended dividends, as a result of COVID-19. There was a significant drop in borrowers on payment holidays from 28% of the loan book at the end of June to 5.8% on the release of their results. Critically, they also put through very conservative IFRS9 provisions for loan losses at 10x what they booked for loans actually in default. Despite this, they still made an underlying RoE of 18% in the first half of the year.

Asian financials rose 5.8% in August with developed Asia outperforming (Japan and Hong Kong were particularly strong) while emerging market Asian financials lagged, affected by China. Within Asian emerging markets, India was relatively strong with sentiment supported by government relief measures (including -loan restructuring rules and SME funding) which along with recent capital raises has reduced risk within the system.

Recent management feedback from HDFC Bank (a core holding in the Trust) was reassuring (non-performing loans are expected to peak below the GFC level of 2.1% compared to 1.4% currently) with confidence in the asset quality of the loan book under moratorium (98% of salaried customers are still receiving wages). Given HDFC Bank’s superior underwriting track record and customer focus (86% of corporate customers rated AA and above) we remain cautious about extrapolating these comments more broadly for the sector.

The sector has seen a recovery from its March lows but remains well below its pre-COVID-19 levels with valuations reflecting a high level of macro uncertainty. With government guarantee schemes in place, we do not expect visibility on asset quality until later in the year but remain confident in the ability of our bank holdings to absorb losses given capital strength and loan loss reserve building. Given the front-loaded nature of provisioning under IFRS 9 (with many banks having guided for a peak in provisioning in H1), we believe a recovery in the sector is likely to be sharp once there is greater clarity on the economic outlook.

We added to a number of our smaller bank holdings during the month, including Webster Financial Corporation, a Connecticut-headquartered bank, Signature Bank, a commercial real estate-focused New York bank, Sparebanken Midt-Norge, a Norwegian regional bank, and One Savings Bank following its better than expected results. We reduced holdings in a number of our property and casualty insurance companies, including Arch Capital, and reduced our holding in PayPal Holdings. As a result, gearing increased to 9.6% over the month.

08 September 2020

Nick Brind

Fund Manager

    John Yakas

    Fund Manager