Hermes’ Mark Sherlock has adopted an overweight allocation to financials in the £780m US SMID fund on his bullish outlook for banks.
Financials now account for 29 per cent of the fund, around a 1 per cent overweight, with a skew to financials in the top 10. Signature Bank (2.3 per cent), Wintrust Financial (2.2 per cent) and SEI Investments (2 per cent) are all top 10 holdings, totalling 6.5 per cent.
Sherlock’s investment universe is US small and mid caps; “anything that’s not in the S&P 500”, he says. This translates as companies with a market cap of between $1-10bn, which tend to have a higher domestic exposure of around 70-80 per cent compared to the average in the S&P 500 of 50 per cent.
“We like that exposure as we are positive on the underlying economy,” Sherlock says. “The unemployment rate is 4.3 per cent, the Fed has raised rates and there are signs of confidence in the underlying economy.”
Within the financials allocation, Sherlock is overweight insurers and banks with some exposure to Reits, although he says these are fully valued on the back of rising rates.
He favours regional banks, where he says the net interest margin – the difference between the interest paid on money lent by the bank and the money paid on customers’ deposits – has shrunk due to long bond rates.
“As rates go up, the net interest margin should expand again. In the coming two years loan growth should accelerate again.”
“The health of the consumer is important as 60 per cent of the US economy is consumer-based. In the last few years we have seen more employment, wage growth coming through, the price of property stabilising and more people exposed to the stockmarket through 401(k) retirement savings plans. It will lead to a wealth effect and people happy to take on debt.”
Sherlock looks for “differentiated banks”, such as East West Bank, which caters exclusively to the US and Chinese markets and therefore has a sticky customer base, “conservative” Bank of Ozarks, which Sherlock says has low loan to value ratios of 40 per cent and First Republic, which specialises in “jumbo mortgages on super prime property in San Francisco”.
Sherlock says he was “not tempted to get involved” when bank valuations moved up aggressively in Q4 2016, but increased the fund’s exposure to banks in Q1 this year when the ‘Trump bump’ faltered, taking the weighting from 10 per cent to 12 per cent.
“When people were cautious and banks were underperforming, we picked up Sterling Bank and topped up our other bank holdings.”