Polar Capital Global Financial has reported a return on net assets of 5.3% for the year to the end of November 2015. this compares well to a total return of 0.9% for the benchmark MSCI World Financials Index, and total return of 3.8% delivered by the broad MSCI World Index. The Company’s share price total return during the year was 6.2% reflecting a small narrowing of the share price’s discount to the Company’s NAV. The full year dividend was 3.225p, an increase of 4% on the year before.
The managers point out that the fall in the oil price resulted in the share prices of banks in oil dependent economies falling. In Texas where they have no exposure and Norway where the fund’s largest holding is DNB, Norway’s largest bank, share prices briefly recovered from initial share price weakness then fell again as a recovery in the oil price petered out. They say history would suggest that any loan losses from the fall in the oil price should be very manageable. Texas, for example, suffered a surge in bank failures in the 1980s following the collapse in oil prices in the early 1980s but this was almost entirely due to their exposure to commercial real estate and construction loans as opposed to the oil industry.
Banco Santander and Standard Chartered, where they have no exposure, fell sharply over the year, with both banks raising capital to strengthen their balance sheets. In the last year Polar Capital Global Financial purchased holdings in a number of small banks that floated, including Banca Sistema in Italy, Skandiabanken in Norway, and so-called ‘UK challenger’ banks, Aldermore and Shawbrook. Along with One Savings Bank, another UK challenger bank that the Company already had a holding in, the three UK banks performed extremely well in the first six months of the financial year reflecting their high profitability relative to peers and from strong loan growth. All three focus primarily on small business and property lending such as buy-to-let. However, changes announced by the UK government regarding taxation of buy-to-let properties and concerns on capital requirements saw share prices come under pressure in the second-half.
US banks, post an initial sell-off at the beginning of the year on weaker economic data and therefore an expectation that the Federal Reserve would be slower to raise interest rates, performed well. As the US economy has recovered and loan growth has picked up then higher interest rates are seen as the key catalyst to driving stronger share price performance. US banks are seen as beneficiaries of rising interest rates as they should result in wider net interest margins (the difference between what they pay for funding and charge for loans to customers). JP Morgan and PNC both performed well against this background but Citigroup lagged, in part, reflecting its exposure to emerging markets.
US regional banks, such as First Republic and Pacific Premier in which the Company has holdings, performed even better as they are seen as more interest rate sensitive while also benefiting from stronger loan growth. In a similar vein to smaller banks in Europe, when comparing them to their larger peers, US regional banks are generally more focused on commercial banking, have little or no legacy issues and tend to be seen in a more favourable light by politicians and customers. As a result they are expected to continue to see stronger earnings growth than their larger peers.
There was a wide dispersion of returns from emerging markets during the year exacerbated by a further depreciation in the currencies of some versus sterling. Despite the headline fall in emerging market indices the Company had a couple of holdings that performed well, although others holdings did not perform at all well. The Company’s exposure to emerging markets fell from approximately 22% when the Company was launched in 2013 to around 5% currently. The Company’s largest exposure is to India, with holdings in Indiabulls Housing, Jammu & Kashmir Bank and Yes Bank with other holdings invested in banks in the Czech Republic, Taiwan and Georgia.
In other sub-sectors, insurance stocks performed strongly benefiting from 2015 being a record year for M&A activity, the sector being perceived as defensive and a lack of significant catastrophe losses. The year just passed was the tenth consecutive year with no hurricanes making landfall in the US, the longest streak since records began in 1851. Real-estate investment companies or REITs made positive returns albeit varying in performance across geography and focus. Asset managers saw a significant dispersion in returns with those focusing on US or emerging markets performing poorly while those in Europe, such as Azimut Holdings an Italian asset manager in which they have a holding, performed well.
Fixed-income securities holdings provided good returns despite the volatility in some underlying government bond markets. Conversely business development companies (BDCs), which provide largely senior secured financing to US small and mid-sized corporate, suffered from the volatility emanating from the US high yield market on the back of the sell-off in energy related bonds. This resulted in some significant falls in some BDCs but those held by the Company, including Ares Capital and Main Street Capital, provided good returns over the year.
Technology is having a big impact on the sector. One of the key trends is the switch customers are making to bank via their mobile phones or on-line versus via a branch. This is leading to lower costs as banks need fewer and smaller bank branches to service. To take advantage of this trend they added to the Company’s holding in Atom Bank, a new start-up bank. Atom is a digital-only bank and plans to launch savings and current accounts products in the first half of this year. It received its banking licence in 2015 and at the end of the year it announced that BBVA, the second largest Spanish bank with a market capitalisation of EUR42.0 billion, would be taking a significant stake.
Litigation, which has been a headwind for the banking sector, materially reduced in the second half of 2015 and outside a very small number of banks we do not expect it to be a material issue going forward. In May a number of banks settled with regulators with respect to outstanding foreign exchange (FX) market manipulation investigations. JPMorgan, Citigroup, Barclays and Royal Bank of Scotland, agreed to pay over $5bn in fines adding to fines that were paid towards the end of 2014 to other regulators. UBS paid a much smaller amount, having previously received conditional immunity for its cooperation.
Regulation has had a significant impact on the sector, in particular on the amount of equity capital that banks need to operate. Outside expected small adjustments to capital requirements, for example with respect to harmonising the way it is calculated, there is much better visibility and therefore increasing confidence on the amount of capital that banks can return to shareholders in dividends and buybacks. Recent pronouncements from regulators have suggested much greater scrutiny on lending by banks to certain borrowers, such as buy-to-let in the UK and commercial real estate lending in the US and this could impact capital requirements going forward.
PCFT : Polar Capital Global Financial outperforms