Is now the time to invest in financial companies?

Financial companies have long been vital to the global economy. The sector is made up of international banks, fund management firms, payment providers, wealth managers and insurance companies, amongst others.

Often thought of as dull (insurance) or complex (banks), this sector has been out of favour for some time and tends to trade on lower valuations to other areas of the market.

However, as with other walks of life, technological advances are now encouraging innovation. And, as these companies tend to do better in periods of rising interest rates, investors’ attention has turned to the sector once again.

An influential role

The financial sector makes up a significant part of many stock markets. For example, there are now 256 financial companies in the FTSE All-Share Index*. In comparison, the next most populated sectors in the index are consumer discretionary with 86 companies, and industrials with 84. This means financial services accounts for a remarkable 22.11% of the FTSE All-Share, as well as 55.44% of the FTSE SmallCap*.

The impact of rising interest rates

The financial sector has historically been among the beneficiaries of interest rate rises. This is because profit margins expand for some companies as rates increase.

Because interest rate rises tend to point to a strong economy, borrowers are usually in a better position to make loan or mortgage payments. Banks can also make money from the difference in savings and lending rates.

However, today’s environment is not as straight forward as that. As Alexandra Jackson, manager of Rathbone UK Opportunities fund, pointed out in an interview earlier this year, financial stress is increasing in the economy, because of how many strains there are on consumer incomes right now.

“We think the high street banks in the UK may actually have to give up their gains from interest rate rises because of these higher, bad debts that they’re going to experience,” she said.

“However, insurers are a really nice way to get a bit of leverage to rate hikes, without some of that quite binary outlook that we see in the banking sector,” she continued. “So, we’ve been adding to life insurance companies which are benefiting from a both rising interest rates and also very chunky growth in their premiums in areas like cybersecurity.”

And of course, insurance is often a legal requirement, not a ‘nice-to-have’, which makes the sector more resilient in an economic downturn.

How to get exposure

Funds focused on this area of the market can be found within the IA Financials and Financial Innovation sector, which was launched last year by the Investment Association.

This sector, which was one of six introduced to increase diversity, is for portfolios investing at least 80% of their assets in equities of financial services companies and related sectors.

These include sub-sectors such as banking, insurance, capital markets, fintech, and consumer finance in any country.  While some have a specific focus on a particular country or industry, such as insurance, others will take a broader approach.

Funds to consider

Jupiter Financial Opportunities 

This fund, which is managed by Guy de Blonay, has broad exposure to a number of different industries that come under the umbrella term of financials. Currently, the fund’s top 10 holdings include prominent household names such as Mastercard, the global payment technology company**.

In an analysis of opportunities for financials, Guy de Blonay, noted how Covid-19 had accelerated the trend towards online banking and payments systems. He also highlighted fintech as a key theme. “Over the past few years, the traditional world of finance has been shaken up by a wave of fintech companies that have taken advantage of digitalisation to disrupt the incumbent financial stalwarts,” he stated.

Polar Capital Global Insurance 

The aim of this fund is to provide an attractive total return from investing in international insurance companies – irrespective of the wider economic and financial conditions. Nick Martin, the fund’s lead manager, can call on many years of industry experience when he’s putting together his portfolio of between 30 and 35 holdings. He seeks to identify and allocate capital to the best in class proven companies, where underwriting is absolutely key. 

The fund’s largest stock position is currently in Marsh McLennan, a leading global professional services firm that boasts an annual revenue of nearly $20bn and clients in 130 countries**. Other prominent names among its top 10 holdings include Arch Capital, which writes insurance, reinsurance, and mortgage insurance on a worldwide basis.

GAM Star Credit Opportunities 

And of course, there are not only opportunities to invest in the shares of financial companies, but also their debt. This fund is a high-income bond portfolio with a unique strategy – it invests in the ‘junior debt’ of investment grade companies. This allows the fund to generate a good income, whilst still keeping a high-quality portfolio.

It is heavily invested in the debt of financial companies, as this is where the best opportunities often lie. Names among the current ten largest holdings include HSBC, General Accident and Credit Suisse**.

Other investment options

Of course, you don’t always need to buy into a fund that focuses on financial services companies to get exposure to this sector.

In the world of fixed income, Colin Finlayson, manager of Aegon Strategic Bond fund agrees that there are opportunities in the financial sector today. “The recent weakness in investment grade corporate bonds has made the risk/reward more attractive.,” he said. “Financials, in particular, stand out. They have been beaten up by the weakness, and there has been some forced selling, but they are well-capitalised and at attractive valuations.”

When it comes to equities, financials is also a prominent sector in the JOHCM UK Dynamic fund managed by Alex Savvides, with a 27.5% share of assets** and in the Artemis Income fund, where it represents 30.6% of the portfolio**.

And of course, the sector is not restricted to the developed world. In fact, structural trends are also at play in emerging markets, where more and more of the population are starting to access its services in the form of online banking, for example. FSSA Global Emerging Markets Focus is taking full advantage of this, with financial companies making up almost a third of the portfolio, with names such as ICICI Bank, HDFC Bank and ICICI Lombard general Insurance Co. Ltd among its top ten holdings**.

*Source: FTSE Russell factsheet, 30 September 2022
**Source: fund factsheet, 31 August 2022

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and do not constitute financial advice.

Published on 10/10/2022