Advertisement Feature

Financials: Strong potential hidden by weak sentiment

Nick Brind, Co-fund Manager, Polar Capital Global Financials Trust, writes for MoneyWeek about the positive outlook and recovery potential for the financial sector.

City building and sunlight

“It was the best of times, it was the worst of times.”

While setting the scene for his novel of the extremes of that time, the first sentence of Charles Dickens’ A Tale of Two Cities could easily have been describing the very cyclical nature of financial markets. Those brave enough to buy equities or corporate bonds in March this year, at the height of the pandemic, will have done very well outside a small number of sectors such as energy, hospitality and transport.

We have seen a number of bank shares such as those in Nordea Bank, Scandinavia’s largest bank, and First Republic Bank, the 12th largest in the US, trading at a higher level today than at the turn of the year. Equally, the likes of Intact Financial Corp, a Canadian property and casualty business, Progressive Corp, a US personal lines insurer, and Hong Kong Exchanges and Clearing are all higher on the year. The latter two along with First Republic Bank have reached all-time highs in the past couple of months.

Nevertheless, the financial sector, which encompasses not only banking, insurance and stock exchanges but also asset managers and consumer finance companies among other businesses, has underperformed global equity markets by around 22% since the start of the year. Understandably, investors have been focused on the winners of the crisis, most notably the technology companies that have seen their share prices rise substantially this year.

Banking and insurance are incredibly attractive businesses if managed well. An insurer generates profits in two ways. If it is a good underwriter of risk, then it will make a profit from the premiums it receives from policyholders, while it will also generate a further profit from the income it receives having invested those premiums along with other investments it already holds on its balance sheet. Similarly, if banks are sensible underwriters of risk, they can earn attractive returns over an economic cycle.

However, share prices of banking and insurance companies have been hit hard by Covid-19, the latter over concerns around claims from travel insurance, event cancellations and business interruption policies. They were also hit on concerns around rising loan loss provisions resulting from a rise in company failures and unemployment as a consequence of government-imposed lockdowns and the change in spending behaviour.

Nevertheless, the insurance sector is seeing insurance rates rise for some classes of business at their fastest rates for many years, with some industry commentators saying it is the most attractive market in over a decade. Similarly, the banking sector has changed materially over the past 10 years with capital levels having risen substantially. Therefore, banks are significantly more robust and were able to provide substantial support to customers at the beginning of the pandemic.

As a result, there are significant opportunities within the sector. Today, banking stocks trade at levels, on average, only seen during the global financial crisis when the solvency of the sector was in question which it is not today. We believe earnings are likely to see a sharp jump over the next couple of years as economic recovery continues to gain traction, on the back of the huge fiscal and monetary stimulus globally, as the Covid-19 crisis abates and dividends and buybacks restart. 

Expectations are low for the sector to outperform. It remains unloved and undervalued but, as we have seen many times in equity markets, expect the unexpected. In A Tale of Two Cities, Sydney Carlton, a dissolute English lawyer, is redeemed at the end of the story. Along with other value stocks that have performed poorly, investors may well look back in 12 months’ time and see Covid-19 as the catalyst. Despite the dark times, the outlook is looking more and more positive while the recovery potential remains substantial.

Important information: This document does not constitute an offer or solicitation of an offer to make an investment into any fund managed by Polar Capital. Polar Capital LLP is a limited liability partnership number OC314700. It is authorised and regulated by UK Financial Conduct Authority and registered as an investment adviser with the US Securities & Exchange Commission. A list of members is open to inspection at the registered office, 16 Palace Street, London, SW1E 5JD.

The law restricts distribution of this document in certain jurisdictions; therefore, persons into whose possession this document comes should inform themselves about and observe any such restrictions. It is the responsibility of any person or persons in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not seek to make any recommendation to buy or sell any particular security or to adopt any specific investment strategy. All opinions and estimates in this report constitute the best judgment of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital. Past performance is not a guide to or indicative of future results.

Recommended

Latest issue
Investments

Latest issue

Latest issue of MoneyWeek magazine,
16 Sep 2021
I wish I knew what tapering was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what tapering was, but I’m too embarrassed to ask

Tapering is the reduction in quantitative easing provided by a central bank. But how does it work?
11 Aug 2021
HSBC’s profits surge – but will the share price?
Bank stocks

HSBC’s profits surge – but will the share price?

Pre-tax profits at banking giant HSBC rose from $1.1bn last year to $5.1bn in 2021, but the share price remains depressed.
6 Aug 2021
Bank on financial stocks with this investment trust
Investment trusts

Bank on financial stocks with this investment trust

Banks, though not British banks, look set for a strong rebound, making this investment trust worth researching.
22 Jun 2021

Most Popular

The times may be changing, but don’t change how you invest
Small cap stocks

The times may be changing, but don’t change how you invest

We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few be…
13 Sep 2021
Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
Should investors be worried about stagflation?
US Economy

Should investors be worried about stagflation?

The latest US employment data has raised the ugly spectre of “stagflation” – weak growth and high inflation. John Stepek looks at what’s going on and …
6 Sep 2021