Market review

Financials had a very strong July as softer US inflation data and weaker than expected employment data led to a sharp rotation in equity markets, which benefited the sector. Easing concerns around the outcome of the French election also helped sentiment. Against this background, financials as illustrated by our benchmark index, the MSCI All Country World Financials Index, rose 3.7% while the Trust’s net asset value rose by 4.8% due to strong stock selection. This was partly offset by an underweight exposure to US regional banks, which are seen as beneficiaries of a Trump presidency and were strong following the poor performance of President Biden at the US presidential debate, and overweight exposure to reinsurance stocks which lagged the benchmark.

Insurance

A combination of concerns around the incidence of Atlantic hurricanes this year and the CrowdStrike induced outage led to some weakness in share prices of the subsector during the month, for example, Arch Capital and Munich Re. Due to La Nina conditions in the Pacific and warmer ocean temperatures, there is an expectation that 2024 will be a much more active hurricane season. Hurricane Beryl is the earliest category 5 hurricane to make landfall in any year on record and added to these concerns. We have a meaningful exposure to reinsurers and we continue to see the risk/reward as attractive as our holdings in Bermuda and Lloyds of London both trade on low multiples.

Reinsurance rates have risen significantly in recent years and reinsurance companies have used that as an opportunity to conversely reduce the amount of risk they have written, in part reflecting that other classes of business have also seen a sharp increase in rates and profitability as well. The subsector also remains very well capitalised to withstand a large loss, with the usual caveats around any forecasts. Nevertheless, we used the opportunity to sell our holding in Munich Re and reinvest part of the proceeds in Hannover Rueck which, due to its greater use of retrocession (the reinsurance of reinsurance), would be less exposed to a large loss.

Alternative asset managers, that have a very good window into the state of the US economy considering the number of companies they lend to and invest in, are not seeing any concerns as yet.Over the past couple of months, we had spent some time doing a deeper dive into cyber risks due to our holding in Beazley having significant exposure, although other holdings all have some. In the risk disclosure, it notes its Solvency II ratio in a one in 250 years cyber event, would remain above 200% all things being equal and we understand this would include an attack on Amazon Web Services and the indirect impacts that this would have on businesses that are reliant on its services. The CrowdStrike induced outage was not in the playbook but comfort around the minimum time, namely eight hours before a policy comes into effect for a policyholder to make a claim on business interruption, and limits on the amount of individual claims, gave us confidence to use the selloff to add to our holding.

Banks

Banks were a strong contributor to performance in July. In contrast to China and Hong Kong, where financials performed poorly and we have no exposure, Korean banks saw strong gains, with the MSCI Korean Financials Index up 9.3%, following solid results and further momentum in the government’s ‘Corporate Value-Up’ programme designed to enhance shareholder value in a market that has long suffered from the so-called ‘Korean discount’. The Trust’s exposure is through holdings in both Shinhan Financial and KB Financial Group: the former can trace its roots back to 1897 and allegedly made its first loan, if it can be believed, secured against a donkey.

During the month, the government unveiled tax reform proposals which included a reduction in the highest inheritance tax band from 50% to 40% and lower dividend tax for investors of value-up companies. Further proposals included reducing the tax on savings accounts. While the reforms would require bipartisan support, they represent a step in the right direction and demonstrate commitment to the initiatives. Despite the rally in share prices, both banks currently trade at around 0.5x price to book for a 9% return on equity. For comparison, US, European and Japanese banks trade on average at 1.2x, 0.8x and 0.7x price to book ratios for 10.6%, 10.3% and 7.5% return on equity respectively.

Barclays and OSB Group were also strong contributors. Barclays has outperformed this year, with management outlining a credible plan to reallocate capital to higher returning divisions along with the distribution of >£10bn through dividends and buybacks out to 2026 implying a total yield of >10% per annum. As with other UK banks, Barclays’ structural hedge (swaps used to manage interest rate risk) is being reinvested at higher rates, providing a tailwind to earnings supporting a relatively resilient revenue profile. OSB Group performed well, in part, we believe, on relief that the incoming Labour government has not proposed any radical legislation on the buy-to-let market to which it is a large lender.

Volatility

The sharp reversal in the Japanese yen over the past month was not unexpected nor that this would have consequences, but the dramatic crash in Japanese equities at the beginning of August was not expected and brings to mind Mark Twain’s quote: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”. We remain open-minded about the outturn for equity markets. All things being equal, the weaker US employment data, even if distorted by Hurricane Beryl, would suggest the US economy is slowing and the risk of a recession has risen. Conversely, alternative asset managers, that have a very good window into the state of the US economy considering the number of companies they lend to and invest in, are not seeing any concerns as yet.

For example,  Mike Arougheti, CEO of Ares Management (a holding in the Trust) noted in response to the recent market sell-off following weak US jobs data, “We don't have a crystal ball, but we have data that we see in our private market portfolios that is telling us something different. And we've been consistent on that. So two years ago, when the markets were calling for a recession, we weren't. And so, we try not to get worked up as long-term investors in any one singular headline. But we are not seeing anything in our private portfolios that would argue for what we're seeing in the market today. I personally feel like it's an overreaction, but we'll keep collecting data and react accordingly.”