Polar Capital Global Financials: value opportunity or a trap for the unwary? 

Global financial stocks and the funds that invest in them have been hit hard by the pandemic, but there is a chance that they may have been oversold.

It has been a difficult time for investors in the £158m Polar Capital Global Financials Trust (LON:PCFT) with the NAV falling 21.3% in its latest half-year accounts to the end of May. The share price return has been even worse with the trust sliding to a wider than normal discount of 11%.

A challenging period

Most of the trust’s assets are invested in banks and non-life insurance stocks with both areas being badly affected by the pandemic. The prognosis was so gloomy that Warren Buffett sold around $6.9bn of banks and financial stocks from Berkshire Hathaway during the second quarter.

Over the six months to the end of May the biggest detractor from PCFT’s returns were its US and European bank holdings, with the cut in interest rates – which hits net interest margins − and the expected rise in bad debts affecting their future earnings. The non-life insurance sector, which is normally considered fairly defensive, was also weak because of concerns about its exposure to business interruption cover and travel insurance.

Writing in the accounts, managers Nick Brind and John Yakas said that in their view the downturn brought on by COVID-19 will be an earnings event for the sector given its underlying profitability and capital buffers, not a capital one, and therefore the upside for the sector remains material.

“Banks have seen the sharpest falls in share prices, taking their valuations down to levels only previously seen during the global financial crisis when the solvency of the banking sector was in question, unlike today. So while the falls are easy to understand, as banks have to bear the brunt of losses arising from what is expected to be the deepest recession since the 1930s depression, equally the upside here is the greatest when a sustainable recovery starts to get momentum.”

Positive thinking

Another fund manager that is taking a positive view is Nick Greenwood, who runs the £74m Miton Global Opportunities Trust (LON:MIGO). He opened a new position in Polar Capital Financials in August.

“With bond yields very low financials have been avoided by many investors and have fallen to the level last seen during the Great Financial Crisis. This seems, to us, an overreaction as post 2008 banks have shored up their balance sheets and are in a far better position than they were during the banking crisis.”

It is possible that the unprecedented scale of government actions and those of central banks will dampen the losses that banks have to take, thereby suggesting that loan losses may not be as bad as other less deep recessions, although it is too early to say for sure.

If the number of infections continues to rise or the debt defaults are worse than expected then banking stocks will continue to come under pressure, but if a vaccine is approved or the economy improves then investors can expect a strong rebound.