A combination of incoming Europe-wide regulation, the rise of passive investing and a sustained period of ultra-low interest rates have all been weighing down on sentiment for asset managers and insurers in recent years.
However for Thomas Moore, manager of the Standard Life Equity Income Trust (SLEIT), the financial sector is proving a fertile ground for investment.
At the end of September 2017 Moore had around 44% of SLEIT allocated to financials, as he believes that the sector provides an attractive combination of yield and growth potential. To get an insight into how big a conviction call this is, it is more than double the next largest weighting of the portfolio which stands at 17.8% and is allocated to industrials.
Venturing far away from the crowd is an integral part of gaining an edge in a competitive field, as Moore explains:
‘Our portfolio looks very different from our peer group, that’s because we focus on our conviction levels rather than index weightings.’
By extending his and his team’s focus right the way down the capitalisation spectrum, including large caps, mid-caps and small caps, he says the trust has managed to avoid the crowding seen elsewhere in the peer group.
This crowding has been especially evident in large cap pharmaceuticals, where the Trust has a zero weighting because he believes that cash generation is actually very poor among these multinationals. This therefore poses serious questions over their ability to continue to pay dividends over the medium term.
It’s also been seen among bond proxy stocks, as Moore explains:
‘As an asset class bonds have been performing well for three decades and that has also been reflected in the share price of many bond-like equities in sectors such as consumer staples, and that has resulted in some very high valuations.’
Pharmaceuticals and consumer staples are therefore two areas he is keen avoid. In stark contrast, the valuations on financials have been beaten down to levels that Moore believes were unjustified.
Moore has a positive view on the insurance sector, anticipating that Europe-wide Solvency II rules on the amount of capital that EU insurance companies must hold to reduce the risk of insolvency will improve the overall health of the sector. UK insurers Aviva and Prudential are among the largest holdings in the Trust.
‘We took the view that actually the attitude of regulators was quite pragmatic, the life insurance companies were given time to comply with the rules and we were confident all our holdings had sufficient capital.’
‘That’s turned out to be the case and gradually the perceived risk on the life insurance sector has reduced, which means valuations have started to improve, and the companies have delivered strongly on cash and have continued to grow their dividends during this period.’
Beyond insurers, Moore is also seeing potential in companies with very balance-sheet-light activities such as asset managers.
Fund manager River & Mercantile has a predominately institutional client base, running assets for many of the UK’s biggest pension schemes, it sits within the Trust’s top twenty holdings.
Premier Asset Management, also makes the top twenty, diversifying exposure in the sector as its focus is on retail clients.
While these asset managers’ business models differ, Moore is keen to point out the characteristics that unite them, and make them ideal portfolio additions.
‘We see a wide range of opportunities across these different sub sectors. We look for high levels of cash flow generation when selecting holdings for our portfolio. This cash is paid out in the form of dividends which makes us confident in the Trust’s ability to deliver increased dividends to its shareholders in the years ahead.’
The opinions expressed are as of November 2017 and are subject to change at any time due to changes in market or economic conditions. This material is for informational purposes only. This should not be relied upon as a forecast, research or investment advice. The value of an investment can fall as well as rise and is not guaranteed – an investor may get back less than he/she put in. Past performance is not a guide to future performance.
Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority.
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