Is now the time to back financials?

Investing in financials has long divided opinion. Traditional financial stocks – such as banks – have been out of favour for over 10 years now. They were hit hard last year for a number of reasons including thinner margins on lending and the ban on dividend payouts by regulators.

However, the Bank of England gave a huge vote of confidence to the sector in December, declaring that UK banks were rock solid and their balance sheets “strong enough to absorb Covid losses of £200 billion”. A better-than-expected end to 2020 was boosted by the restoration of suspended payouts and February marked a return of bank dividends.

Time to invest in banks?

Now, with rising inflation and household savings at record levels, many investors might be asking themselves if it’s time to back banks – especially since their valuations remain attractive in absolute terms and relative to wider equity markets.

TwentyFour Absolute Return Credit fund manager, Chris Bowie, likes financials as a strong theme for 2021 and beyond. He told us: “Last year, bonds rallied very hard in those sectors receiving explicit government support, such as transport – they became very expensive. By contrast, some banks and insurance companies became cheaper.

“I tend to favour banks where the bank itself is so secure, it has such high capital ratios, that I am tolerant of their junior bonds, meaning they’re riskier bonds. So I would rather own the junior bond of a strong bank rather than the senior bond of a weak bank.” NatWest, Virgin Money and Investec Bank are among the fund’s top 10 holdings*.

Chris also likes building societies. “I like Nationwide Building Society and the Coventry Building Society, where we can loan them money through the bond market and enjoy a nice income,” he said. “Because they’re mutuals and they don’t list on the stock market, they don’t have the option of tapping the stock market to raise money. So their balance sheet tends to be stronger than other banks.”

Opportunities in insurers

Investing in financials isn’t just about banks, of course. Insurers are worth a look too.

Nick Martin, manager of Polar Capital Global Insurance, said: “Last year sentiment was hit hard. But people forget that pandemics are often excluded in policies. Underwriters simply can’t take on open-ended exposures. So, while there were some underwriting costs from covid – for travel insurance and cancelled events, for example – losses have been manageable.”

Sid Chand Lall, manager of Marlborough Multi Cap Income, believes that the insurance sector is often overlooked by investors keen to follow the trendy stocks. “It’s been a bit more fashionable for investors to be chasing the tech and energy sector,” he said, “but the insurance sector has actually been very reliable – its cash flows have become increasingly more resilient.”

And what about the asset managers themselves?

There’s also an investment opportunity in asset managers that are likely to benefit from increased fund flows and higher market levels. An exodus from cash would be very helpful for such companies. Sue Noffke, manager of Schroder Income Growth, saw an opportunity at the beginning of the pandemic to snap up a position in M&G, an asset manager which was demerged from Prudential in late 2019.

She told the AIC: “We took advantage of the turmoil in the market with the onset of the pandemic to opportunistically establish a new position in M&G starting in March 2020 and added to it in the autumn. Our view, in contrast to that taken by the market at the time, was that the company was able to pay the dividend and was likely to do so without intervention of regulators. This proved to be the case and our expectations are that the company can maintain its dividend and possibly grow it modestly over time. M&G offers good income generation with high but sustainable yields.”

Overseas financials

Investors can also look globally when looking for ideas in financials. Joanna Kwok co-manager of the JPM Asia Growth fund has almost 25% of her fund in financials* – not usually associated with a growth tilt – such as Ping An Insurance (Group) Company of China, which provides insurance, banking, investment, and internet finance products and services.

Joanna told us: “Rising wealth and smart use of technology means that the demand for banking, insurance and wealth management products in Asia will only grow. We are seeing underlying structural trends happening across the board. The quality of management in this sector is important and we pay a lot of attention to it.”

Fintech opportunities

The raciest of financial stocks, however, are arguably to be found in the fintech sphere.

They make up a chunk of the fastest-growing businesses in recent years, buoyed by increased connectivity and cutting-edge software. This month, digital banking company Revolut became Britain’s highest-valued private tech company – valued at £24 billion.

As the economy improves many believe that fintechs will to continue to grow the market shares they have won over the last 18 months, prompting an increase in investor appetite.

Newcomers are floating on markets more frequently than ever, it seems. One of many examples is American trading platform Robinhood, which has shaken up the broking industry by offering commission-free trading through its app. The firm is gearing up to go public in New York.

Hear more Robinhood on this podcast with Mick Dillion, co-manager of Brown Advisory Global Leaders.

Funds investing in financials

For those who believe that financial services stocks – in whatever form – have much to offer investors, there are almost 30 Elite Rated funds with more than 20% of their holdings in financials**.

Equity funds include Jupiter Financial Opportunities – a concentrated portfolio of around 50 stocks, currently favouring banks over insurers, with Bank of America, JP Morgan and Capital One in its top ten, as well as Visa and PayPal – and Artemis Income, which has almost 32% of its portfolio in financials including top ten holdings Barclays, Aviva and the London Stick Exchange*.

When it comes to bond funds, GAM Star Credit Opportunities has a unique strategy of investing in the ‘junior debt’ of investment grade companies – the majority of which are financial companies. This allows the fund to generate a good income, whilst still keeping a high-quality portfolio. Rathbone Ethical Bond is also heavily weighted towards financials, with positions in HSBC, Lloyds Banking Group as well as Aviva, Scottish Widows and M&G*.

*Source: Fund factsheet, 30 June 2021
**Source: FE fundinfo, 30 June 2021

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.