Guy de Blonay, manager of the New Star Global Financials Fund, comments below on the weakness and volatility affecting stockmarkets over the summer months and explains why the fund will maintain a cautious but opportunistic approach. The New Star Global Financials Fund is rated 'AA' by Standard & Poor's and the manager is 'AA' rated by Citywire*. The fund returned 101.88% in sterling terms over the five-year period to the end of August compared to the FTSE Global Financials Total Return Index, which rose 8.91%#.
Financial stocks were plagued by weakness and volatility over the summer months. The New Star Global Financials Fund's defensive positioning, with lower exposure to equities and relatively high levels of cash and cash equivalents, aided performance as markets headed downwards from mid May. The fund's cautious stance and use of short positions in index futures bolstered performance until mid July, when intervention by the US Securities & Exchange Commission to ban 'naked short-selling' combined with the sliding oil price and better-than-feared corporate results to ignite a relief rally. In the subsequent weeks, the financial sector continued to experience unusual volatility.
In the difficult trading conditions from mid July, an outright underweight position in banks was no longer the obvious strategy. Instead, the fund focused on companies with little to no sub-prime structured products but with diversified income streams, strong franchises and exposure to emerging markets. Core holdings included hedge fund managers, which can take advantage of volatile conditions and have the potential to perform strongly in all market conditions. They also included diversified insurers with strong balance sheets and healthy capital ratios. JP Morgan's recent statement highlighted deteriorating third quarter trading conditions. The approaching results season will be monitored with interest but the fund is likely to avoid highly-leveraged companies such as investment banks.
The fund will remain opportunistic and look to add selectively at a sub-sector level. A position was initiated recently in the banking group, Intesa Sanpaolo. It is a leader in the Italian market and has an international presence focusing on Central and Eastern Europe and the Mediterranean basin. The group's de-rating, in line with the European banking sector, provided a good investment opportunity. Intesa Sanpaolo has a defensive business profile, with 80% of its income coming from retail banking, and it has a minimal exposure to investment banking and capital markets. It is well funded with high retail deposit levels and has a robust capital base that may be increased by the sale of non-core assets. HSBC is another defensive holding, with its wide geographical diversity and a healthy dividend yield. It is also well capitalised in a sector suffering from capital constraints.
The fund continues to steer clear of major domestic banks in the UK, US, Ireland and Spain. Instead, it has reinvested in regions with the potential to benefit from local structural growth. In Asia, interesting opportunities may be found in Japan although the risks associated with a prolonged economic downturn need to be monitored carefully. Holdings include Mizuho Financial Group, which was one of the few major banks to announce year-on-year net profit growth and has the potential to outperform its peers.
In the West, Canadian banks look attractive because the country has relatively resilient growth prospects as a result of its resources sector. Canadian banks, such as Canadian Western Bank and National Bank of Canada, are well placed to benefit from the limited competition within the industry, their relatively healthy asset quality, strong liquidity position and capital strength.
Sector share price trends over the coming months will be influenced by a number of factors, the most important of which are the macroeconomic influences on interest rate movements and the possibility of receding inflation. The potential resurrection of the US housing market through the new US housing bill will be closely monitored. This $300 billion government initiative is intended to refinance troubled mortgages and boost the oversight of Fannie Mae and Freddie Mac. More specifically for the banks, important access to funding would occur if the securitisation market re-opens; this would remove the pressure on central banks as a source of funding.
It is important that investor enthusiasm returns to the sector because there are likely to be further capital raisings later this year and in 2009. More capital will be required because of the worsening economic environment is leading to further deterioration in credit quality on all business lines. This is affecting the banks' already stretched balance sheets, with loan portfolios suffering from higher levels of provisioning.
The write-downs and losses associated with sub-prime and structured products should begin to abate as prices stabilise but in the short term major financial institutions will potentially experience further pain before they improve. Macroeconomic data is expected to worsen throughout the remainder of the year; dividend cuts are inevitable for the US banks and this will feed through to European banks.
In this environment the fund will continue to focus on well-capitalised banks that offer minimum risk in terms of dividend cuts. While deteriorating credit quality will affect the banks, valuations are beginning to look attractive because there are still regions where earnings will continue to grow at a healthy rate.
Over the last year or so, trading conditions have been significantly worse than expected but there are areas within the financial sector that should cope better with them. They include emerging markets, where there is structural growth although rising inflation is a concern. The US, meanwhile, also has short-term recovery potential as the first economy to slow down is often one of the first to rebound.
* At 31.07.08
# Source: Lipper, performance data in sterling, NAV to NAV, net income reinvested to 29.08.08
Past performance is not necessarily a guide to future performance. The opinions expressed here represent the views of the fund manager at the time of preparation and should not be interpreted as investment advice.
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