- Global Industry Analyst
United States, Intermediary
Change
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The new inflationary and economic regime coupled with bank-funding-stress challenges are driving elevated volatility within financials. This is fueling a wide range of outcomes across companies as markets have engaged with the impact of higher rates and funding costs on cash flows and margins. Critically, when financials experience the extreme levels of volatility we are seeing today, we historically have witnessed meaningful shifts in market share and significant dispersion between winners and losers. In our experience, the better-positioned financials get stronger and gain share, while the weaker become even more challenged and, in many cases, either give up share or sell to generate maximum value. We believe the widening dispersion between winners and losers creates alpha opportunities in these environments.
Dispersion drives opportunities in financials
Low interest rates, a liquidity-rich environment, and the limited-risk backdrop of recent years contributed to a “leveling of the playing field” for much of the financials services and fintech landscape. Differentiating good business models from bad was not rewarded and many lower-quality companies benefited from bad risks.
The new, higher-rate environment is not unequivocally “good” for financial services; however, higher rates and less liquidity mean that good companies can once again distinguish themselves. The key takeaway is that dispersion is back.
In addition, disruptive technologies are having a profound impact on how consumers engage with financial institutions and their products. This is another growing source of dispersion in outcomes among stocks as financial companies navigate these shifts in different ways.
Coupled with a change in the macro backdrop that has resulted in increased levels of market volatility, we believe this could be one of the more compelling environments for long/short investing since the global financial crisis.
Key financials opportunities
Financials represent approximately 13% of the MSCI World Index, comprising a meaningful part of global equity markets. The financials opportunity set is large, complex, and rich given the dispersion of company leadership, quality, growth, and technology. In our view, this is fueling key themes for both long and short investing, such as:
Near term:
- The impact of increased funding costs and lower liquidity across the US banking system
- Share gainers versus share losers in the asset management industry — core, benchmark-driven active management remains in secular decline while certain alternative categories continue to gain share (e.g., private credit)
- European banks — early stages of a broader re-leveraging process that could benefit certain countries/individual banks
- Japanese banks — monetary policy change (higher-rate environment) could create meaningful upside opportunities for certain Japanese banks
Longer term:
- Financial technology (digitalization of services)
- Financial inclusion (expanding services to millions of unbanked)
- Ongoing bank consolidation
Financial services potential risks
The biggest risk to the long/short financial opportunity set (i.e., dispersion opportunity) is that we return to a period of massive policy support and potential low/no rate environment, which we view as a highly unlikely outcome given ongoing inflationary pressures.
Bottom line on financial services dispersion
We expect more dispersion across global financial services stocks over the next decade than we have seen in the past 25 years. The period of massive global liquidity is over. The range of outcomes as a result is wide and the impacts on global capital markets and bank balance sheets are incredibly complicated. We think dispersion across stocks, sectors, and geographies is supporting numerous secular themes in long/short investing in financials.
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