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.

The banking sector has been a significant drag on the UK market. Since 2006, the All Share index has risen by 19% but the five banking constituents of the FTSE 100 have, on average, fallen by 70%. As Nick Brind, co-manager of the Polar Capital Global Financials Trust (LSE: PCFT), notes, this was not just the result of the financial crisis. Since mid-2013, the five have slipped by 30% while the All-Share has returned 46% and the MSCI Global Financials index 77%.

A difficult domestic market

It’s not hard to see why. With interest rates at zero, it is virtually impossible for UK banks to make sufficient margin to cover costs, bad debts and a reasonable return on capital. Fee income is under relentless pressure from specialist providers of insurance, investment advice and foreign exchange, competition in the commercial market is intense and investment-banking income has withered. Regulators stopped banks paying dividends in 2020 and their overall rate of corporation tax is 8% higher than standard. “UK banks are not a good guide to the opportunities in the sector,” says Brind.

Banks in the US and emerging markets have fared better so PCFT has prospered, returning 102% since mid-2013 and 54% since the trust survived a continuation vote at the cost of buying in 40% of its shares last April. This has led to an acceleration in relative performance, which has been 14% ahead of the global financial index since then. The shares now trade at a small premium to net asset value (NAV), enabling PCFT to reissue most of the shares it bought back. Assets have increased to £250m and though the yield has dropped below 3%, dividend growth is likely to resume this year.

Over 90% of PCFT’s portfolio is outside the UK; 63% is invested in banks, 14% in insurance, and 10% in “financial technology” (such as PayPal and Mastercard). Nearly half of assets are in North America and 20% in Asia ex Japan. The sector has started to outperform but Brind believes there is much more to go for.

“Banks underperformed in the pandemic by more than in the global financial crisis,” he says, “but the rise in loan losses has been muted while payments of deferred interest have resumed. US banks are incredibly well reserved so provisions are likely to be released in 2021-2022 , enabling a resumption of share buybacks.” A strong recovery in earnings is expected, helped by the steepening of the yield curve. “This is very good news for the sector as the performance of banks is highly correlated to bond yields.”

Rising interest rates bode well

A 1% rise in US interest rates, says Brind, causes bank earnings to rise 12% in year one and 20% in year two. The discount of share prices to book value for global banks has narrowed from 30% to 10% but Brind sees 20% upside in the US and 30% globally, with asset values boosted by the release of provisions as well as by earnings. Given how well the banks withstood this crisis, it is even possible, he thinks, that they could be rerated in a more benign regulatory environment.

Exposure to emerging markets has been reduced despite the structural growth opportunities and a sector that is “more profitable and more dominant than in developed markets”. Financial technology companies have benefited from an acceleration in the shift of transactions online while pricing in insurance markets is firm. Covid-19 losses are estimated at $60bn-$70bn but balance sheets are strong and valuations moderate.

Financials usually out-perform by 23% in the 12 months from market lows, says Brind, “but have barely outperformed since the Covid-19 low and have halved relative to the MSCI World index since 2006”. Given the encouraging outlook the trust is geared, with borrowings of 9% of net assets.

Recommended

Private pensions: act early to avoid a big inheritance tax bill
Pensions

Private pensions: act early to avoid a big inheritance tax bill

Frozen inheritance-tax thresholds mean HMRC is taking ever more in death duties. But there are steps you can take to avoid it, says David Prosser.
18 May 2022
Should you buy Vodafone shares, or steer clear?
Share tips

Should you buy Vodafone shares, or steer clear?

Vodafone grew revenue by 4% and profit by 11% last year, and offers investors a 6.4% dividend yield. So should you buy Vodafone shares? Rupert Hargrea…
17 May 2022
2021 Château La Mascaronne rosé: a work of art from Provence
Wine

2021 Château La Mascaronne rosé: a work of art from Provence

This wine soars above all others with its grace, refinement and impressively long finish
17 May 2022
The UK jobs market is still red hot – but will it last?
UK Economy

The UK jobs market is still red hot – but will it last?

For the first time ever, there are more job vacancies than people to fill them, and wages are rising at a decent clip. But that might just be a tempor…
17 May 2022

Most Popular

Get set for another debt binge as real interest rates fall
UK Economy

Get set for another debt binge as real interest rates fall

Despite the fuss about rising interest rates, they’re falling in real terms. That will blow up a wild bubble, says Matthew Lynn.
15 May 2022
Is the oil market heading for a supply glut?
Oil

Is the oil market heading for a supply glut?

Many people assume that the high oil price is here to stay – and could well go higher. But we’ve been here before, says Max King. History suggests tha…
16 May 2022
High inflation will fade – here’s why
Inflation

High inflation will fade – here’s why

Many people expect high inflation to persist for a long time. But that might not be true, says Max King. Inflation may fall faster than expected – and…
13 May 2022