Archived article

Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

It isn't just the obvious firms which have a large exposure to the sector
Thursday 30 Mar 2023 Author: Ian Conway

With banks still very much the focus of the market’s attention, should investors rethink not just their direct exposure to the sector through individual stocks but also their indirect exposure through funds and investment trusts with large weightings in the sector?

Shares has examined some of the funds and trusts with the largest reported exposure to financial firms as a proportion of total assets and asked if or how they have changed their investment allocation following the recent upheaval in the banking sector.

SETTING THE BACKGROUND

It’s important to put the failure of firms like Signature and Silicon Valley Bank, and the bailout of Credit Suisse, in their proper context before we talk about banks in general.

Both US banks were specialist lenders, with Signature serving the cryptocurrency market and SVB providing capital to start-up companies and alternative banking services to the fund industry.

SVB fell prey to a series of missteps by management, most obviously the decision to invest heavily in long-duration, low-yielding US government bonds just ahead of a rate tightening cycle, but there were also serious questions over aspects of its corporate governance.

Concern has spread to US regional banks, as they make up the bulk of the loans to small-and medium-sized companies and to the property sector.

According to figures from Goldman Sachs, US banks with under $250 billion of assets are responsible for 50% of commercial and industrial lending in America, 60% of residential real estate lending and 80% of commercial real estate lending.

Concerns over Credit Suisse on the other hand seem mainly to revolve around the Swiss regulator’s treatment of bondholders.

WHAT DO THE SPECIALISTS HAVE TO SAY?

Top of the list in terms of exposure to financial stocks are the specialist fund Polar Capital Financial Opportunities (BCRYMF7) and investment trust Polar Capital Global Financials (PCFT), which invest across the sector globally.

Between them, managers George Barrow, John Yakas and Nick Brind have decades of experience in analysing financial stocks and take an active approach to running the fund and the trust.

In the case of the investment trust, as of 28 February 93% of assets were invested in large-cap stocks with a 41% weighting in the US market.

Top 10 stocks included blue-chip names such as Bank of America (BAC:NYSE), Berkshire Hathaway (BRK.B:NYSE), HSBC (HSBA), JPMorgan (JPM:NYSE), Toronto Dominion (TD:TSE) and Wells Fargo (WFC:NYSE).



Shares in the trust have understandably had a rough ride this month, dropping from 157.7p on 9 March to 136p on 20 March, but the managers have been quick to address market concerns.

In assessing the fallout in US banks, the Polar Capital team focused on the capital strength and balance sheet liquidity of holdings, what percentage of their assets are in US government bonds and mortgage-backed securities, and exposure to commercial lending.

As a result, holdings in small and mid-cap US banks have been reduced to almost nil in the fund and the trust, while fintech (financial technology) exposure is low at 14.5% in the fund and just 5.5% in the trust and is focused on mature, profitable businesses like Mastercard (MA:NYSE), Paypal (PYPL:NASDAQ) and Visa (V:NYSE).

‘As with the banking sector, this crisis will reinforce the competitive position of the larger fintech players that are not reliant on external financing and will benefit from a flight to quality,’ say the managers.



WHAT ABOUT BOND MANAGERS?

Monthly dividend-paying fund TwentyFour Select Income (BJVDZ94) has a diversified portfolio of less-liquid fixed-income investments including corporate bonds, asset-backed securities, bank capital (including AT1 securities) and leveraged loans, which earn it a premium in terms of returns.

At the end of February, around 36% of its assets were in bank securities, 35% were in asset-backed securities, 12% were in insurance assets and 10% in European high-yield bonds.

The fund doesn’t own any AT1 bonds issued by Credit Suisse but AT1 bonds do make up 25% of its portfolio.

The managers argue ‘the rationale for holding European and UK subordinated debt is sound’, and that European regulators have been quick to distance themselves from FINMA, the Swiss bank regulator, confirming that bondholders will be put above equity holders in terms of seniority in the event of a default.

That may not be much comfort to some investors, but sub-investment grade debt (rated below BBB or Baa by the agencies) carries more risk than investment grade which is why it carries a higher interest rate.

Shires Income (SHRS), which is managed by Iain Pyle of Abrdn, has a 40% weighting in financials through a mixture of holdings in stocks and bonds.



All the trust’s fixed-income holdings are financial and include high-yield bonds issued by banks  Santander (SAN:BME) and Standard Chartered (STAN) as well as insurers General Accident
and RSA.

Like the other managers, Pyle sees limited risk of another Silicon Valley Bank or Credit Suisse scenario playing out in UK or European banks thanks to tighter liquidity regulation and stronger asset bases, although both events have implications for investors.

‘(The failure of SVB) has already caused expectations for rate rises to decline and for equity risk premia to increase, while the bank sector has sold off materially. Carry trades across the asset spectrum are likely to come under pressure.

‘The defensive positioning of the trust and investment in banks with strong capital positions provides good protection in this situation and we would be inclined to add on weakness, but without doubt there will be further consequences to come.’

WHAT ABOUT EMERGING MARKETS?

Interestingly, many emerging market-focused investment trusts tend to have a large exposure to financial stocks, including Henderson Far East Income (HFEL), JPMorgan Indian Investment Trust (JII) and Vietnam Holding (VNH).



Mike Kerley, manager of Henderson Far East Income, argues Asian economic growth will be a lot higher than the global average this year thanks to China’s reopening combined with the government’s domestic policy agenda.

Meanwhile, emerging market inflation risk and by extension interest rate risks are less acute than in the US or Europe which is supportive for financial stocks.

Finally, the dividend outlook for the region looks bright as earnings growth is set to accelerate compared with last year which will translate into higher levels of cash flow and distributions.

JPMorgan Indian has a 34% weighting in financials, with banks making up five of its top 10 holdings as of 28 February.

Hugh Gimber, JPMorgan’s global market strategist, believes the most likely impact of the recent financial sector stress will be a slowdown in bank lending. ‘We expect tighter credit conditions to drag on economic activity over time, therefore reducing inflationary pressures. The challenge for both investors and the central banks is that they don’t yet know by how much bank lending will slow.’

Vietnam Holding also focuses purely on local companies, in particular those which benefit from increased consumption due to the country’s rising per-capita income, the trend towards urbanisation and industrialisation.

It has a 34% weighting in financials, almost all of which is in banks, which given concerns around the future of several large property developers goes some way to explaining why the market and the trust have struggled this year.

Disclaimer: The author owns shares in Henderson Far East Income and TwentyFour Select Monthly Income

‹ Previous2023-03-30Next ›