Equity markets rallied further in May despite continued weak economic news and almost universal scepticism about the rally. Nevertheless, the lack of a spike in infections following the relaxation of lockdowns and an expectation of further fiscal support from governments is seen as very positive news. Against this background, financials lagged the rise despite benefiting from a sharp rally from growth stocks into value stocks in the last week of the month. The Trust’s net asset value rose 7.1% in May, while our benchmark index, the MSCI ACWI Financials Index, rose by 3.4%.

The biggest contributors to performance over the month were our holdings in payment companies, in particular PayPal Holdings and MasterCard, followed by some of our non-life insurance holdings such as Arch Capital. Detractors included some of our Indian holdings, namely HDFC Bank and Axis Bank. AIA Group was also weak, exacerbated by the decision by the Chinese government to announce it would be imposing a new controversial security law on Hong Kong.

US financials outperformed over the month with non-life insurance stocks supported by evidence of an acceleration in rate increases (the CIAB Commercial P&C Market Index showed increases of close to 10% year on year in the first quarter). The data showed broad-based repricing across lines of business. Following the increase in primary and retrocessional rates, we are also now seeing rate hardening in reinsurance rates, with data from Hyperion-X showing the highest rate of growth since 2002 and the third highest overall increase since 1992.

Payment companies as highlighted above were particularly strong in May. There is a growing recognition that the pandemic is likely to prompt lasting behavioural changes which will accelerate the shift away from cash with payment companies a key beneficiary of this structural trend (PayPal’s net new active accounts averaged 250 thousand a day in April, a growth rate of 135% year on year). Recent data published by Visa also points to a significant improvement in volume trends in May, likely supported by stimulus cheques as well as an easing in restrictions, with a particularly strong recovery in debit volumes now up year on year having been down in April.

Emerging market financials rose over the month across most countries aside from China and India. Sentiment on China was affected for the reason highlighted above, as the approval by the National People’s Congress of a controversial security law for Hong Kong is expected to undermine the city’s autonomy and could lead to the US decision to withdraw Hong Kong’s special status as a separate customs territory. There is also a clear risk of an escalation in rhetoric between the US and China in the run-up to the November US presidential election which points to continued uncertainty. The Trust is underweight Hong Kong and China with our exposure primarily in regionally focused companies such as AIA Group and Prudential.

European financials lagged the rally in May with the banking sector relatively weak. The European Commission proposed a €750bn Recovery Fund which would include €500bn in grants to be dispersed over 2021-24 with allocations skewed towards southern Europe. The proposal has the backing of Germany and France and consequently has a greater chance of approval. If passed (requiring agreement from all 27 member states), the fund is politically and economically significant for the region as it would involve common borrowing to provide grants weighted towards southern European countries in recognition that they face a disproportionately large impact from the pandemic. Our only exposure here is to Banca Generali.

Looking forward it is still too early to tell the level of provisions banks and consumer finance companies will have to take over the coming 6-12 months. US banks have been much quicker than others to provide for loan losses. However, JP Morgan, for example, signalled on their first quarter analyst call that they would have to take further significant provisions in the second quarter as the economy had deteriorated much more than expected when they set the level of provisions they deemed prudent to cover the recession.
While they are not alone, conversely the fiscal largesse of governments and the actions of central banks will dampen losses that banks and consumer finance companies have to take suggesting loan losses during the recession will not be as bad as other less deep recessions. The relief provided to borrowers, whether from direct cheques to the unemployed, money to cover furloughed employees, grants, guaranteed loans, mortgage holidays etc will be turned off at some point over the coming months and defaults will likely pick up sharply.

Against that background it is worth considering the actions of BlackRock’s largest shareholder, PNC Financial Services, which we own in the Trust and is one of the largest banks in the US. In May it sold its 22% stake to raise around $14bn. PNC’s management team is seen as astute and was one of the winners of the global financial crisis buying troubled National City, a Cleveland, Ohio-headquartered regional bank with $150bn in assets in the depths of the crisis. They believe this crisis will also provide significant opportunities to buy distressed assets.

In the short term, until we see more evidence of defaults, the sector could rally from the historically low valuations it is currently trading at as the economic outlook continues to improve and we start to see a sharp rebound in activity. Whether any short-term rally is sustainable only time will tell but the longer-term value in the sector remains compelling which will be realised when economies and interest rates start to return to a more normalised environment.

05 June 2020

Nick Brind

Fund Manager

    John Yakas

    Fund Manager