Market review
May was a good month for global equity markets as solid economic data and Fed Chair Jerome Powell’s pushback against the potential for further rate hikes supported global risk assets. Consequently, US Treasuries rallied during the month, with yields on 2-year and 10-year US government bonds falling 16 and 18 basis points respectively, while high-yield credit markets were also strong. Against this background, financials, as illustrated by our benchmark index, the MSCI All Country World Financials Index, rose 2.2% while the Trust’s net asset value rose by 3.2%.
JPMorgan Investor Day
JPMorgan, which is the Trust’s largest holding, held its Investor Day towards the end of the month in which it reiterated the strength of its business, “fortress” balance sheet and industry-leading profitability as well as where it is looking to grow and improve efficiency. While the company raised earnings guidance, this was overshadowed by management commentary that buying back stock “greatly” in excess of 2.0x tangible book value would be a mistake. With JPMorgan trading at 2.3x tangible book value, that raised the question – are its shares expensive? We do not think so, but equally they are no longer cheap (we wrote briefly about this in What is a bank worth? | Polar Capital Global Financials Trust).
Nevertheless, it is still planning to buy back in excess of $8bn of stock this year and a significant majority of sell-side analysts, for what that is worth, rate it as a buy, albeit with limited upside. If one had bought its shares back in 2021 when it last traded at this valuation you would have still made between a 25-35% return, showing that even at a relatively high price-to-book value for a bank, it is not that expensive. Reflecting the strength of its balance sheet and better management of interest rate risk, it was able to take advantage of the US regional bank crisis to buy First Republic at a very attractive level, which has boosted earnings.
However, we agree buybacks are less accretive and that keeping more of the cash gives JPMorgan options and it has lots of options to grow. It plans to open 500 new branches over the next three years, a reminder that there are only two banks in the US, namely Bank of America* and Wells Fargo, that can be argued to have a national footprint. It is also spending over $17bn in technology this year. Consequently, it is investing to grow and reduce cost. It highlighted one example where, for ‘know your customer’, it had processed 230,000 files in 2023 up from 155,000 the previous year with 20% fewer people. We believe it has shown why it will continue to be a winner in the sector.
Ares Management Investor Day
Ares Management, another Trust holding, also held their Investor Day in May. With over $420bn in fee-paying AuM, it is one of the largest alternative asset managers globally. Tilted towards private credit, it has been a big beneficiary of the tailwinds in that part of the industry. Good performance across its funds with extremely low levels of default has allowed it to build up a very strong reputation and it highlighted the opportunities for it to continue to grow for the foreseeable future with a target of $750bn AuM in four years’ time.
US Treasuries rallied during the month, with yields on 2-year and 10-year US government bonds falling 16 and 18 basis points respectively
We have touched on the reasons we like the industry before but they include the fact that the capital they raise from investors is locked up for many years as they offer clients no daily liquidity to reflect the illiquidity of the underlying investments. Consequently, they cannot suffer the periodic outflows their traditional asset management peers do which leads to huge advantages. The risk/reward over the past couple of years has also tilted towards private credit as they can invest on behalf of their clients at higher yields and lower leverage.
Go back five years and private credit was highly correlated to the flywheel of the private equity industry. While that remains an important driver, over recent years the industry has expanded into managing assets on behalf of insurance companies, which has been a big driver, and latterly wealth management.
There remain significant opportunities in infrastructure debt as well as Asia, to name two others. They also benefited from the US regional bank crisis in 2023 and higher capital requirements US banks face as part of the so-called Basel Endgame, resulting in further opportunities to buy assets banks have been looking to divest.
Criticism of alternative asset managers
The private equity industry has never been short of criticism, going back to the 1980s with the record-breaking buyout of RJR Nabisco in 1988 by KKR chronicled in Barbarians at the Gate by Bryan Burrough and John Helyar, or more recently Plunder by Brendan Ballou. The reliance on leverage has always been the key risk but also a key driver of returns, and with interest rates back to a more normalised level it is reasonable that the strong performance of private equity over the past decade cannot be sustained at the same level.
Other criticisms include a failure to mark valuations to market in a timely manner, or so-called volatility laundering, as valuations for private equity or credit funds show less volatility than their peers that invest in publicly listed equities. Ultimately, it is performance that has driven flows and that driver will not change. Transparency is also poor for those not invested in the underlying funds, but the advantages of not being listed include having management teams that are more incentivised to manage companies undistracted by onerous reporting requirements and an ability for owners to replace them much more quickly.
Nevertheless, while we still like the long-term attractions of the subsector, with the strong performance over the past six months we reduced our exposure after month-end, selling holdings in Blue Owl Capital and Partners Group Holding while adding to our holding in Ares Management. Intermediate Capital Group, a UK alternative asset manager in which we also have a large holding, reported much stronger results during the month leading to upgrades. They have proved the exception, with most peers seeing flat to falling earnings guidance as realisations have not picked up sufficiently.
* not held
