Financials outperformed wider equity markets in August, led by the US, as bond yields rose in anticipation that Federal Reserve Chairman Jerome Powell might use the Fed’s annual symposium at Jackson Hole to signal a change in the outlook for US monetary policy on the back of the stronger than expected recovery in the US economy over recent months. Against this background, the Trust’s net asset value rose 4.4% over the month, while our benchmark index, the MSCI ACWI Financials Index, rose 5.1%.

Relative performance was affected by holdings in the likes of Mastercard and Mannapuram Finance which were weak over the month, the former on concern around the impact of the Delta variant of COVID-19 on cross-border travel. During the month we added to a number of our SMID-cap bank holdings which have also lagged recently despite reporting strong second quarter results. This was offset in part by the sale of our holding in Visa to reduce our exposure to payment companies.

Progress on vaccinations has given some confidence that the latest wave of infections will limit hospitalisations and allow continued economic reopening.

US financials rose 6.3% in August despite a resurgence in COVID-19 cases linked to the Delta variant.  Progress on vaccinations has given some confidence that the latest wave of infections will limit hospitalisations and allow continued economic reopening. US economic growth exceeded pre-pandemic levels in the second quarter however, while businesses have learned to adapt, the latest PMI surveys suggest they have been affected by hiring constraints and supply chain delays and the Delta wave is impacting consumer confidence.

As noted above, Jackson Hole and, specifically, Powell’s speech, took centre stage in August. The outcome was, however, relatively balanced. While Powell’s declaration of “clear progress toward maximum employment”, in addition to “substantial further progress” towards the average 2% inflation target strongly signalled that asset purchases will be scaled back this year, this hawkish tilt was offset by his comments that any tapering timeline should not carry a “direct signal” regarding future interest rate rises.

Asian financials rose 3.3% in the month with relative strength in ASEAN markets, Taiwan and Australia while Hong Kong and China underperformed. Economic data on China missed expectations and highlighted a deceleration in industrial production and retail sales growth with activity affected by COVID-19 restrictions as well as floods impacting Henan province. A tightening in credit conditions this year has also been a constraint on growth with the administration focusing in particular on the property sector and putting pressure on developers to curb leverage.

Aside from mixed macro data for China, sentiment has also been affected by a sustained period of regulatory tightening across the technology, education and healthcare sectors. We have seen a number of companies in China pledge support for the government’s “common prosperity” vision although it remains unclear if this will be sufficient to ease the regulatory scrutiny on them. Our exposure in Ping An Insurance weighed on the Trust’s performance in the month which was affected by broader Chinese market pressure as well as regulatory focus on its real estate investments (we view the risk as manageable given they represent only 5% of insurance funds while Ping An has already made a sizeable provision against its exposure to property developers).

The remaining second quarter results were reported during the month which continued an encouraging trend with the sector seeing earnings upgrades...

European financials rose 3.3% during the month and, as in the US, insurance stocks were relatively strong following a period of underperformance. The Delta wave has shown signs of plateauing across a number of countries in the region and consequently allowed a continued reopening of economies with mobility trends largely unaffected. The remaining second quarter results were reported during the month which continued an encouraging trend with the sector seeing earnings upgrades, primarily on lower provisioning estimates but also slight upgrades to pre-provision income which came ahead of expectations for the majority of those that reported.

OSB Group, the specialist buy-to-let lender, reported strong earnings for the half year with an underlying RoE of 24%, supported by lower provisioning and good cost control which remains materially lower than its peers. In August, Rabobank announced their intention to pay a special extra coupon on their Tier 1 Certificates in December resulting in a jump in the bond price. Distributions on the Certificates had been limited to date in 2021 by the ECB’s capital return restrictions, which will lift from the end of September.

Looking forward over the next few months the key question for investors is whether the recent rise in bond yields suggests markets have been too sanguine on the risks that the reflation trade is dead and that bond yields will start to edge back towards their pre-pandemic levels with consequences for investor positioning. Or do we return to the ‘lower for longer’ environment for bond yields that we saw in the years preceding the pandemic?

We continue to see positive earnings revisions for the sector, supported by the increase in capital returns while, unlike many other sectors, valuations remain very low relative to that of wider equity markets

To quote Donald Rumsfeld, former US Secretary of Defense, it is one of those “known unknowns”. Either way we continue to be constructive on the outlook for the sector and the Trust. We continue to see positive earnings revisions for the sector, supported by the increase in capital returns while, unlike many other sectors, valuations remain very low relative to that of wider equity markets. Furthermore, should the reflation trade start to regain momentum then we would expect the positive relative performance of the sector since November last year to pick up again sharply.