Financials more than just a cyclical play

However, the sector is far broader than it is given credit for, with a diverse range of companies that can be both defensive and growth-orientated. Are financial funds condemned to be a bull-market phenomenon or can they offer all-weather returns?

It is certainly true that financial funds cannot escape the asset cycle. The sector includes banks, insurance companies, and asset managers together with payment companies, consumer credit companies, leasing companies and property.

Many of these are significantly exposed to economic growth and the expansion and contraction in credit conditions.

Susan Sternglass Noble, manager of the £44.3m AXA Framlington Financial fund, says banks and other financials can be very cyclical, particularly diversified financials such as asset managers. “These businesses have high fixed costs and therefore high operational leverage. There are also exchanges and consumer credit groups that tend to be very cyclical,” she says.

She also points out that some banking groups tend to be more cyclical than others. This seems to be supported by the performance of some financials funds. The financials sector as a whole is the top-performing sector of the past 12 months (source: FT), delivering returns of 34.14 per cent. It can be no coincidence that this coincides with a significant bull run in equity markets. Equally, funds such as the Jupiter Global Financials fund have substantially outperformed in bull markets and underperformed in bear markets.

However, the performance of different types of financial stocks in the past year shows the sector is not homogenous. The general financials sector has been by far the greatest beneficiary of the rise in stockmarkets and is up 48 per cent in the past 12 months. It is followed by the banking sector, up 43 per cent.

In contrast, more defensive areas such as non-life insurance companies and Reits have significantly lagged the market – rising 23 per cent and 18 per cent respectively.

Financials managers argue the sector has its share of defensive options. Ms Sternglass Noble says that going into the crisis in 2008, she had a significant weighting to insurance companies, which proved defensive. She says that non-life insurers, in particular, are defensive because they have little or no exposure to equity markets. These did a good job of preserving capital for investors during those difficult times.

Guy de Blonay, manager of the €41m (£35.3m) Jupiter Global Financials fund, says financials remains a diverse group. “The correlation between sectors is very small. In 2007, the financials index was flat, yet groups such as Citigroup saw falls of 40 per cent or more. Another sub-sector, exchanges, saw its share price double in the same period. If you pick the right sub-sector at the right time, you can deliver very specific performance.”

Every country has its own asset cycle. Ms Sternglass Noble says: “There are so many banks in so many countries – in some countries financials are highly leveraged and risky, while in others that isn’t the case.”

She also believes an exposure to real estate gives managers the opportunity to choose an offensive or defensive position. There are real-estate companies that have proved extremely defensive, investing in high-quality property with sustainable rents. However, there are also companies that offer more cyclical exposure.

Should financials investors always have the macro environment at the back of their minds? Mr de Blonay and Ms Sternglass Noble consider themselves stock pickers, but will shift their portfolios to take account of the economic cycle.

Ms Sternglass Noble says she is currently in ‘mid-cycle’ mode, but there is significant disparity between the regions. For example, there is steady, if modest recovery, in the US, while Europe requires a more defensive approach.

Mr de Blonay divides his fund into three distinct areas: yield, growth and special situations. At the moment, he is taking down the ‘growth’ portion of the portfolio, largely on valuation grounds.

“We have found that Asia has been a relatively good performer in the past 18 to 24 months and is now in corrective mode,” he says. Elsewhere he points to stocks such as Visa, which were trading at roughly 12 times when they first bought in, but are now at around 20 times earnings.

The financials sector has historically done better in rising markets. However, to condemn it as a purely cyclical play would be wrong. Managers simply have to know when to use it.

Cherry Reynard is a freelance journalist.