In this article, Tom Dorner & Stuart Brown(pictured), managers of the ASI Europe ex UK Income Equity Fund, talk about why they are finding reasons to be positive about European Financials
All European income investors looking for sustainable premium yield need to have a view on European Financials, as more than a quarter of market dividends come from this sector.
Banks, insurers and diversified financials all offer attractive income opportunities for investors willing to find companies in these sectors with solid fundamentals. Financials also have an important role to play in the transition towards a more sustainable economy.
The consensus view has been cautious towards the sector for a long time, often with good reason. Low interest rates have been a headwind, and there has regularly been a fear of regulatory intervention.
We think there are now reasons to be more positive, as capital positions have strengthened considerably and the attitude towards capital return have improved (particularly relative to M&A). We think European Financials provide an interesting opportunity for investors willing to understand the dividend-paying capacity of many constituent companies. Furthermore, we believe Financials offer a compelling combination of both dividend yield and dividend growth.
Insurance – a reliable source of premium yield
The European Insurance sector has been a reliable source of dividend yields in our Fund for several years. The sector has navigated the challenge of low interest rates well by raising prices, improving operational efficiency and shifting investment allocations. As a result, earnings and FCFs have been resilient.
During the pandemic, confidence was dented by extremely volatile markets and regulatory pressure to defer dividends. As we stand today, however, dividends have been largely reinstated and confidence in future dividends is high.
The relative performance of the sector has suffered for the last two years and we think this presents a compelling opportunity to access sustainable premium yields. Capital positions were resilient during the crisis and the sector should continue to offer attractive dividends while building capital.
For example, the leading global insurer Axa has been a core high-dividend holding because we believe the market is not giving credit for the shift towards higher quality P&C earnings and the strength of the balance sheet. It offers a ~7% dividend yield and should build significant excess capital in the coming years, which we think might lead to additional capital returns.
Banks – dividend reinstatement offers opportunity
We have historically been underweight European banks because the low interest rate environment has driven consistent downgrades to sector expectations. At the same time, lending growth has been sluggish and there is the threat of disruption from Fintech players. For many years after the Financial Crisis, the banking sector also faced regulatory creep on capital requirements.
However, in recent years, confidence in the dividend-paying capacity of European Banks has improved. The Covid 19 crisis put a stop to capital returns, but in some cases this has proven to be a deferral rather than cancellation.
In this context, we see the recent ECB announcement to lift the dividend ban in September 2021 as a material positive for income investors. The announcement includes explicit reference to the fact that some banks will be catching up previously skipped dividends, so some banks will be making material returns to shareholders.
The pan-Nordic bank Nordea is a position that we have built in the last 18 months as our confidence in the operational turnaround of the business and balance sheet strength have significantly improved.
Diversified financials – an underappreciated source of dividend growth
In our view, Diversified Financials remind us that not all Financials fit in the traditional ‘value’ category. Indeed some Diversified Financials businesses have access to high levels of structural growth and can therefore provide an attractive opportunity set for the Dividend Growth category of our portfolio.
The private markets asset manager Partners Group has been a long-term holding in the fund and has consistently delivered attractive dividend growth. It benefits from strong investor demand for private markets investments and has expanded the business into Private Equity, Debt, Real Estate and Infrastructure.
The pan-Nordic trading platform Nordnet is a position we took at its IPO last year. It has a leading online trading and savings proposition which is taking share from incumbents. It’s expanding outside its home market in Sweden into higher margin Nordic markets, which should drive earnings.
Financials are important in the transition to a more sustainable economy
As Financials are deeply embedded in the economy and often systemically important, they have an important contribution to make in the move towards a more sustainable economy.
Banks are crucial for ensuring that credit is created and for providing responsible access to finance. Insurers have for many years been at the cutting edge of climate change research and provide the risk / volatility transfer that allows investment in developed and emerging markets.
Diversified Financials like exchanges have a crucial role to play in providing better and more consistent ESG data so that clients can make more informed investment decisions, thereby helping capital to be allocated in a more sustainable way.
Our approach to income investing identifies a variety of income ideas
We think European Financials offer an attractive and diverse range of opportunities across three income categories.
- High Dividend – companies like Munich Re navigated well through the COVID crisis and paid substantial claims, whilst also sustaining their dividends. In the case of some banks like Nordea, we focus on the dividend-paying capacity of the business and management commitment to dividends even if regulators have forced them to defer pay-outs.
- Dividend Growth – a number of Diversified Financials holdings like Partners Group and Deutsche Boerse have attractive growth opportunities that drive high levels of dividend growth, and the resilience of their businesses was demonstrated by sustaining dividends during the COVID crisis.
- Upgrade – in this category we look for businesses where we think dividends are significantly mis-priced. We think Mediobanca is a good example of this as the shares often trade like a Bank but the business is significantly less risky and has a strong position in the Italian Financial Services market.
Historically, there have been good reasons for income investors to be cautious on European Financials. However, we believe this view is outdated and the sector offers opportunities for fundamental investors willing to understand the various dynamics at play.
