The financial sector has been one of the sectors which has shown a higher resilience during difficult times. Inflation is high and recent energy costs increases, as a consequence of the war in Ukraine, and the sanctions to Russia, will go to further feed into this. Investors will need to alter their portfolios to the new reality. Under the circumstances of this environment, financial equities could be an interesting option for investors, and as the experts forecast, will benefit from continued earnings momentum and increases in shareholder distributions.
We wanted to have at the funds with better returns at 1 year annualised, and have asked the fund managers to talk about their strategies, and how the current situation of the markets is affecting them. We had the commentaries from Polar Capital, Algebris Investments and Mediolanum International Funds.
Source: Morningstar 10/03/2022
Polar Capital Funds PLC – Polar Capital Global Insurance Fund
Nick Martin, Fund Manager Polar Capital Global Insurance Fund
The investment objective of the Fund is to provide an attractive total return irrespective of broader economic and financial market conditions. The Fund will seek to achieve its investment objective by investing primarily in securities of insurance related companies worldwide.
Over 90% of the Fund’s exposure is to non-life/property casualty (re)insurance. Non-life insurance is less sensitive to macroeconomic conditions since it is not a discretionary purchase for individuals or companies. Historically the Fund has offered defensive characteristics in challenging and volatile financial markets. In an increasingly global, complex world with accelerating technologies, the value of insurance in helping to manage risk is rising.
Investment Philosophy
The portfolio is managed as a pool of underwriting capital on behalf of the Fund’s shareholders. The Fund seeks to identify 30-35 underwriting specialists that when combined offer a level of diversification that is important in investing in this sector. The Fund Manager flexes the portfolio composition to particular classes of business as premium rates, terms and conditions, and loss activity change. The Fund Manager seeks to identify and allocate capital to the best in class proven companies, where underwriting is absolutely key. This naturally leads the Fund Manager to invest in companies which have more focused underwriting strategies and where management have a meaningful ownership stake and are incentivised on growing book value per share and dividends over time. We believe this is the ultimate driver of share price performance over the long term.
The team do all their own analysis and research with great importance placed on meeting management. Insurance is a promise to pay and therefore an assessment of management integrity is a key part of the investment process.
Algebris UCITS Funds plc – Algebris Financial Equity Fund
Simon Peters, Investment Strategist Algebris Investment
Investors have a problem. Equity markets are down YTD, as are bond markets. The Russian invasion of Ukraine exacerbated this trend. The investment world remains a yield desert, with little-to-no yield. For the first time in more than a decade, central banks globally are changing direction.
Inflation is high and recent energy costs increases are going to further feed into this. Investors will need to alter their portfolios to the new reality. In this environment, we believe financial equities will benefit from continued earnings momentum and increases in shareholder distributions.
Algebris is a €19bn. AuM global asset manager with a long track record investing in the financial sector. The Algebris Financial Equity Fund invests in financial equities globally. Not being tied to a benchmark, the investment team has the flexibility to invest across regions. This flexibility has been a consistent source of Alpha for the fund and has contributed significantly to its outperformance, along with good name selection.
Our case for banks
Inflation and interest rates are going up. Banks’ earnings and dividends benefit in this environment. Interestingly, the European bank sector already offers a dividend yield of >7% and this yield is going up, not down, as earnings are being upgraded. The European bank sector would need to rally ~100% to hit its average 3.5% dividend yield over the last 25-years. The rest of the market is trading closer to its all-time low yields, not its highs.
European banks’ exposure to Russia is limited to a few names. Given transparency in the industry, such exposure is easy to quantify, and we don’t think recent developments in Russia pose a material risk for the sector.
Until the end of 2020, the bank sector had been in a slump for more than a decade while it built up its capital ratios and repaired its balance sheet post the Global Financial Crisis. The banks have proved their resilience by sailing comfortably through the Covid recession. The result is the ECB has recently given permission for banks to distribute excess capital via dividends and share buybacks. No other sector shares the combination of earnings upgrades and momentum whilst close to its valuation lows. Finally, the sun is shining for global banks again.
Mediolanum Challenge Financial Equity Evolution
David Whitehead, Equity Team para MIFL
Challenge Financial Equity Evolution is a Euro-denominated multi-manager equity fund that invests primarily in the global financial services sector. This is achieved through allocations to delegated managers and listed UCITS funds.
Market view
In the wake of inflationary pressures, the prospect of rising Central Bank rates has boosted investor sentiment towards the financial services sector in general, given the expected benefit of higher rates on bank profitability. Moreover, for the first time in over a decade, European GDP growth is likely to outpace that of the US. This macro backdrop of continued economic growth and higher interest rates is likely to drive further earnings growth for banks, especially European banks. However, European bank valuations are still at a discount to their US counterparts and do not reflect any significant long-term benefit to European bank profitability from higher nominal rates. However, in the short term, it is clear that the conflict between Russia and Ukraine has affected bank confidence as investors try to assess the ramifications of the situation for individual banks.
Another important theme to consider for the financial sector outlook is the performance of value versus growth stocks. Despite the strong performance of value stocks, which generally includes the financial sector, the long term picture has not really changed, showing that growth consistently outperformed value over the last decade. Therefore, there is a possibility that value will catch up and that this extreme divergence will narrow further, at least during the first half of this year, as real rates turn positive.
Positioning
The portfolio is currently allocated to two delegated managers, one based in Europe which forms the core of the portfolio, and one based in the US which joined the portfolio in July last year. Both are led by a portfolio manager with over 20 years’ experience. The European-based manager follows a blended approach that includes bottom-up fundamental work, strong valuation discipline and a top-down macro view focused on identifying market catalysts. The US-based manager’s approach focuses on generating alpha from stock selection rather than sector allocation decisions, focusing on company fundamentals and company-specific factors. This combination of different investment philosophies and approaches adds additional diversification at the portfolio level for better risk-adjusted returns.
Within the financial sector, the portfolio is currently tilted towards Europe and the UK, to the detriment of the US and Asia-Pacific. The preference for Europe is more prominent in banks, especially Italy and France, which has contributed to performance at the end of Q4 2021 and so far this year. The portfolio also has a thematic allocation, particularly across payments companies, focusing on long-term players rather than new entrants to the industry. This has contributed greatly in recent months, as these more established companies outperformed, while the newer ones had a more difficult period. This provides the fund with a mix of traditional financial industries along with some emerging thematic areas, such as digital payments and financial technologies, with the opportunity to identify and capture the best risk-reward opportunities.
