Equity markets rose sharply in April on the back of a combination of further support by governments and central banks as well as hope that an expected easing in lockdowns would limit further economic damage. Financials lagged the rally as concerns that the sector will be hit by further losses, whether on loans or due to higher claims on insurance policies, held back shares. Against this background the Trust’s net asset value rose 6.5% while the MSCI ACWI Financials Index rose by 5.2% (in sterling terms).

The biggest contributors to performance were the Trust’s exposure to payments companies such as PayPal Holdings and MasterCard, as well as US SMID-cap banks and some of our emerging market bank holdings. Conversely the biggest detractors were our US non-life insurance holdings, including Arch Capital and Chubb, as well as UK insurer Direct Line Insurance as insurance stocks remained under pressure over the month as the CEOs of Chubb and Lloyd’s of London stated that COVID-19 could lead to the biggest insured loss ever.

US banks outperformed underlying equity markets in April, rising 12.3% despite the weaker macroeconomic data. First quarter results largely came in below expectations, driven by higher loan loss provisions as banks built up reserves despite as yet very limited deterioration in their loan portfolios. However, underlying pre-provision profitability came in better, driven by strong trading and higher net-interest income on the back of a strong growth in corporate loans as well as good cost control.

US banks’ loan loss reserves increased to 1.8% of total loans versus 1.1% in the previous quarter and we would expect them to rise further over the next few quarters as these reserves were set in March, before a significant further deterioration in the outlook for economic activity. Nevertheless, we consider that US banks are taking the right approach to building provision reserves proactively, a stance that contrasts with action taken by most European bank peers this quarter.

Results from payments companies highlighted that, although not immune to the downturn, their business models remain resilient while the pandemic could have longer-term consequences for their growth by accelerating the shift towards digital transactions. Adyen saw a material reduction in travel volumes but still reported processed volume growth of 38% year-on-year supported by a pickup in online retail volumes as consumers adapted to the lockdown. In terms of the card networks, while Mastercard and Visa reported significant falls in cross-border volumes, results were supported by stronger trends in e-commerce.

European banks barely participated in the rally in equity markets. During the month, the ECB announced additional liquidity support as well as more regulatory forbearance, now totalling approximately €250bn equivalent or 270bps of capital, to help the banking sector to continue to lend while absorbing losses related to COVID-19. We are halfway through results season. While they have exhibited similar trends to US banks, there has also been a much wider dispersion in the way banks have provided for loan losses and overall European banks have set aside less in reserves than their US peers which may well hamper their recovery.

Emerging market financials rose 4.6% in April with relative strength in Asian emerging markets, in particular India, Taiwan and South Korea versus Latin America and Eastern Europe. In Asia, sentiment was supported by an easing in restrictions in certain countries while India recovered from a sharp selloff in March with the RBI announcing a series of measures to limit near-term increases in non-performing loans and, importantly, to reduce liquidity stress at Non-Bank Finance Companies. HDFC Bank, the Trust’s largest emerging market holding, reported robust results with evidence of a flight to safety in terms of deposit trends while asset quality comments pointed to continued resilience. We are yet to see the real impact of the downturn in India but view HDFC Bank as relatively well placed given its strong underwriting capabilities and balance sheet strength.

Investment activity during the month included purchasing Tier 2 bonds issued by Jupiter Fund Management to help fund its acquisition of Merian Global Investors, as well as a holding in a legacy ING subordinated bond. We also purchased new holdings in Progressive, a US auto insurer, and Ping An Insurance, a Chinese life assurance company. We sold holdings in Fortune REIT, a Hong Kong REIT focused on shopping malls, Comerica, a Texan-headquartered regional bank, while we also added to our holding in UBS Group on the back of its stronger than expected results.

There has already been a significant collapse in valuations in the sector, unlike some others, with banks trading at levels only seen during the global financial crisis and other subsectors trading at significantly lower multiples. The amount of stimulus that is being provided by lower interest rates, commodity prices and direct injections by governments suggests that when the healthcare scare dissipates and the shackles on economies are removed, the recovery will be very strong.

Nevertheless, we have been surprised that equity markets have rebounded as quickly as they have and feel there is likely to be further negative news flow over the coming weeks and months as many companies unable to secure financing to tie themselves over fail, with the consequent impact on loan losses and higher unemployment. As a result, caution is warranted in the short term but we remain of the view that the downturn brought on by COVID-19 will be an earnings event for the sector given its underlying profitability and capital buffers, not a book value one, and therefore the upside for the sector remains material.

11 May 2020

Nick Brind

Fund Manager

    John Yakas

    Fund Manager