2024 Q4 Portfolio Perspectives

by | Jan 17, 2025

Despite all the headlines associated with the strength of the U.S. market, it is remarkable to look back and see that the MSCI EAFE Index Financials sector has outperformed the U.S. market over the last three years. Since the start of 2022, the EAFE Financial sector has delivered a cumulative return of 40.1% (57.7% in local currency terms) versus the S&P 500 at 29.2% (returns in USD currency terms unless otherwise indicated). A combination of higher interest rates, a benign credit environment (i.e. low default rates) and the resumption of capital returns to its shareholders, created a strong tide that seemingly lifted the entire financial sector.

Financials has been a key detractor of Fund performance over the last three years due to both our underweight to the sector and stock selection within it. As per the chart below, the Fund has been consistently underweight in Financials, which had largely been a performance tailwind over history, however since 2021 it has become a prominent headwind.

To a lesser degree, stock selection within the sector has also hindered Fund performance. Despite the Fund’s Financial holdings having a higher and more consistent profitability track record (refer to table below) with stronger capital reserves, they have largely lagged lower quality European and Japanese Financials that have propelled the sector’s robust returns in recent years.

While we continue to remain focused on quality companies at attractive valuations, we have broadened our research efforts to examine other niches within the Financials sector including auto insurers, private banks, asset managers, specialist corporate lenders and credit guarantors. We believe these niches in conjunction with our preference for traditional banking will provide us with an even greater opportunity set moving forward.

In the interim, we remain patient and believe that the underlying superior quality within our Financial holdings will continue to remain resilient while the lower quality Financials should inevitably reflect lower average valuations once market euphoria subsides.

[1] Source:  Sprucegrove, MSCI, FactSet, Cabot

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