Financials outperformed underlying equity markets in April on the back of better economic data and a small pick-up in bond yields resulting in a shift out of defensive sectors into cyclical ones. US and European banks were very strong, both rising by 9%, while real estate stocks fell over the month. Against this background, the Trust’s net asset value rose by 6.6% while our benchmark index, the MSCI World Financials + Real Estate Index, rose by 5.6%.
Unsurprisingly, the biggest contributors to performance were for the most part our holdings in US and European banks reflecting the sharp moves described above, with JPMorgan and Bank of America being the largest. AJ Bell, the investment platform, also saw its share price rise over 26% on the back of better inflows and higher assets under administration than expected, reflecting the sharp recovery in equity markets in 2019.
Conversely, shares in Arrow Global Group, HDFC Bank and Indiabulls Housing Finance were marginally weaker in April. Sentiment towards Indian financials is jittery, currently not helped by the nervousness over imminent elections. Nevertheless, HDFC Bank reported Q4 results during the month highlighting continuing strong growth, better net interest margins and stable asset quality trends. It is a very high quality bank and we see it as a beneficiary of the retrenchment of more aggressive private banks, such as Yes and Indusind, and state banks that continue to deal with past problems.
As highlighted above, US banks rose sharply over the month following a resilient results season with large cap first-quarter results generally coming in ahead of expectations, albeit estimates had moderated into results. Sentiment towards the sector was also helped by a slight steepening of the yield curve in the month, with the spread between 2-year and 10-year US government bonds increasing 9bps in April to 24bps, amid some better economic data.
Net interest margins for large-cap banks were broadly stable (support from the December interest rate hike was offset by a flatter yield curve) but the results and guidance from US banks point to continued top-line growth even without interest rate rises, although at a slower pace to last year. While sentiment around the US banks has been volatile this year, operating trends suggest little change to earnings expectations and banks have maintained their guidance on loan growth, net interest margins, cost inflation and asset quality.
We have holdings in two asset managers currently, Blackstone and City of London Investment Group, both of which have performed well in a difficult environment for the sector over past few years. Blackstone, with $512bn in asset under management, is the largest of a small group of alternative asset managers that are listed globally. It has seen significant growth in assets under management reflecting its strong franchises in private equity, real estate, credit and hedge funds.
Along with its peers, it has suffered from its shares being relatively lowly rated. Unlike asset managers that focus solely on active equity and fixed income investing, which have suffered from fee pressure and weak flows due to competition from passives, Blackstone’s lower rating is due in part to it being structured as a partnership as opposed to a corporation (it is also more reliant on performance fees/carried interest which is more volatile). This prevents many institutions from owning its shares.
The reasons for being structured as a partnership revolve around tax, with corporations taxed at a higher level than partnerships. KKR, another listed, alternative asset manager, announced last year that it would be converting from a partnership to a corporation, highlighting US tax reform making the move less costly, and its shares responded well to the decision. Not surprisingly Blackstone, having seen the positive reaction, announced in April that it would also abandon the partnership structure. Its share price reacted well to the news (Apollo Global Management also announced it would be converting to a corporation in April while Carlyle Group said it was under consideration).
During the month we sold Indiabulls Housing Finance, following a bounce in the shares in March, and took the opportunity to add to our holding in HDFC Bank. We also reduced our holding in Swedbank, on expectations that the overhang regarding anti-money laundering controls will take longer to resolve. We also added to holdings in AIA Group and Bank Central Asia as well as VPC Speciality Lending Investments, the latter having recently been visited by the manager in Chicago and taking advantage of a sale of shares at a distressed level by their second largest shareholder.
Despite the bounce in the sector over the last month, it remains at a large discount to underlying equity markets reflecting caution around where we are currently in the economic cycle. Nevertheless, leading indicators suggest that growth will remain weak but still positive, in particular that the slowdown in growth in Europe is bottoming and therefore a recession is unlikely, suggesting that investors are too pessimistic. While the sector’s Pavlovian response to economic data and bond yields requires a pick-up to see further recovery in the short term we believe the sector still discounts a much larger slowdown than that forecast by the market.