Polar Capital European ex-UK Income Team
“After the great pandemic dividend reset of 2020, the outlook for European dividends is bright, in our opinion. Most unsustainable dividend payout ratios were swept away as the taboo of dividend cuts was temporarily lifted. 2021 has already seen a nice bounce in dividends from the distressed levels of 2020 and we expect mid-single-digit dividend growth to continue over the medium term for our holdings.
Excessive economic stimulus has elevated the valuations of many assets to levels that look vulnerable to us. In this context, we believe the Fund’s c4% dividend yield looks extremely generous relative to our companies’ own corporate bonds, government bond yields in negative real territory and expensive growth stocks. We have high conviction the Fund will deliver positive real dividend growth over the medium term.
The dividend investment style has been out of favour as valuation multiple re-ratings drove an understandable preference for unusually high capital gains on offer. More recently, there has been clear evidence of excessive risk-taking within financial markets. Our naturally cautious approach has been a headwind to recent relative performance. We believe the absolute cheap valuations of many of our defensive stocks leave them well positioned into tightening monetary conditions.
Our Fund dividend grew faster than the index before the pandemic and was more resilient during the pandemic. It is our high conviction that unusual market conditions have led to a material mispricing of the underlying cash flows of the stocks we own. We expect a normalisation of monetary policy to favour the two pillars of our investment process – valuation discipline and a preference for defensive stocks.”
Polar Capital Global Financials Team
“The resilience of the banking sector over the past two years highlights how positively banks have reacted to the steps regulators have taken since the global financial crisis. Today, banks have strong balance sheets, plenty of liquidity and are more cautious in their lending appetite.
As a consequence, they are well positioned to benefit from the continuing recovery and opening up of economies as the pandemic subsides, notwithstanding any short-term impact from new COVID-19 variants.
While we recognise the uncertainties, we also see the potential for inflation pressures to persist and against that background we believe financials, in particular banks, are a strong insurance policy against higher inflation, bond yields and interest rates.
We believe the tailwinds remain very positive and future threats, in the form of a meaningful increase in defaults over the short term, should be limited by the robust financial health of both consumers and corporates. At the same time, the sector continues to trade on historically low valuations relative to broader equity markets and would be a beneficiary of any further rotation into value.
Looking ahead, we remain constructive on the outlook for the sector, with longer-term opportunities in smaller and mid-cap banks, fintech, asset management and insurance as well as emerging markets.”
Polar Capital Global Insurance Team
“Looking ahead to 2022, we expect book-value growth, the long-term driver of stock performance, to increase from the c10% we expect for 2021. Despite the ongoing pandemic and the fifth consecutive year of heightened catastrophe events, well-managed insurers continue to demonstrate resilient operational performance.
The insurance broker Marsh estimates a compounded insurance price rise of almost 50% over the past three years for its Global Pricing Index. This is resulting in strong top-line growth and material improvements in underwriting margins for our companies. Going forward, reported company results might also be helped by rising investment income as short-term bond yields move higher in a more inflationary environment.
Many investors do not view the non-life insurance industry as a growth industry but that might be about to change. Swiss Re recently estimated the non-life insurance industry will grow at a 4.3% CAGR to 2040 or c5% excluding motor which is more representative for the Fund’s growing opportunity set given its significant underweight in that line of business. Increased awareness of risk from ESG reporting will be a further tailwind.
Despite excellent fundamentals and increased earnings power, the US industry price-to-book was c140% at the end of November, meaningfully below the c150% pre-pandemic level. The Fund’s price to book is also trading at a discount to the benchmark which happens rarely and indicates quality insurers remain on sale. Current valuations and expected double-digit book-value growth should give cash-on-cash returns in the high single digits which are compelling in today’s investment environment.”
Polar Capital UK Value Opportunities Team
“It is a source of frustration but also opportunity that the UK valuation discount did not close in 2021. The UK remains on a material valuation discount to the rest of the world even when sector adjusted. This is despite the most dramatic downside risks of a new relationship with the EU failing to materialize and an advanced vaccine program. As long as the UK remains out of favour, it is a particularly good place to go bargain hunting and the Fund itself remains at a significant discount to the market, creating a double discount.
The resumption of value’s outperformance which paused in mid-2021 requires a re-acceleration of economic growth which we are beginning to see the seeds of. The outlook for returns on invested capital is more nuanced. We believe a company’s performance compared to its peers will matter more than the sector it is in. It will finally become apparent that those winning share within a sector will be able to drive profitable upgrades.
Despite the complex picture, consumer spending should be robust in 2022 while business investment has inflected higher. The forecast economic growth next year is not consistent with the UK’s valuation and, as long as this persists, M&A is likely to continue. We will stick to our knitting, investing in cheap shares with improving returns on invested capital and solid balance sheets.”
