The Hamilton Global Financials ETF (HFG) continues to benefit from excellent performance, having materially outperformed Canadian financials in the last 1, 2, and 3-year periods with lower volatility. Despite the global financial sector’s strong performance over the last six months, there has been remarkably little discussion about it as current interests (AI, the “magnificent 7”, and a fixation on the Federal Reserve/the path for interest rates) have drawn investor attention away from the financials’ attractive fundamentals and valuations. While global financial stocks are showing strong momentum, their valuations remain attractive relative to global equities (see figure 1). We believe this momentum is likely to continue with higher earnings per share (EPS) given economists’ expectations looking for improving global GDP growth (including the U.S.) and the potential for modest rate cuts later in the year.
These factors combined with attractive valuations provide a favourable backdrop for financial services investors. In this Insight, we outline why we believe the Hamilton Global Financials ETF (HFG) can add important diversification to investors’ Canadian financials holdings, which are being negatively impacted by lower domestic GDP growth and productivity.
HFG – Outperforming Canadian Financials with Lower Volatility
With an annualized return of +17.8% since inception[1] and outperformance versus Canadian financials over 1-year, 2-year, 3-years, the Hamilton Global Financials ETF (HFG) is an attractive complement, in our view, for Canadian investors seeking to add diversification to their core Canadian bank/financials holdings while maintaining a comparable volatility profile. HFG is actively managed and provides exposure to the most attractive themes in global financials. Currently, HFG holds 61 positions across 9 sub-sectors, in 17 countries.
Global Financials — Enormous Sector, Favourable Outlook
Notwithstanding some idiosyncratic situations over the past few years, the broader financial sector has proven extremely resilient. It has adjusted to: (i) the failures of three regional U.S. banks and Credit Suisse (which HFG did not own); (ii) heightened competition for deposits; and (iii) the ongoing scrutiny of exposures to commercial real estate (CRE)[1], by marshalling capital, limiting lending, and raising excess liquidity.
Looking ahead, declining inflationary pressures and the potential for interest rate declines in many jurisdictions is expected to support economic growth. At the same time, we believe lower rates should reduce the risk of tail events that depressed valuations in 2022/2023. A reduction in these risks strengthens the argument for higher valuations and returns from the sector.
With economic growth still resilient in the U.S. and forecast to gradually accelerate in Europe, the backdrop for financial sector investments, including HFG, appears attractive.
United States (~45% of HFG) — Strong Economy, Attractive Valuations [2]
The U.S. has the strongest expected economic growth in real GDP amongst the G-10 (2.2%) for 2024[3]; its 3-year growth is forecast to remain elevated relative to peers. In addition to improving fundamentals, the U.S. financials are attractively valued relative to broader U.S. equities (figure 2).
Within the U.S., HFG holds a mix of high-quality, long-term compounders of value (including banks, insurers, and asset managers). In addition, HFG owns companies with relatively low valuations, and earnings trends that are expected to sustainably improve in the latter half of 2024 and into 2025.
Europe (~33% of HFG) — Accelerating Growth Forecasts, Compelling Valuations [4]
Having endured very slow growth for most of 2023, Europe is forecast to see its GDP growth gradually accelerate throughout the next six quarters. We believe European financials are attractive given improving economic performance, strong capital returns (dividends and share buybacks), and compelling valuations.
Within Europe, HFG holds a diversified mix of high-quality financials across 6 countries. Their strong long-term earnings growth is complemented by select companies where valuations and earnings have the potential to exceed expectations. Currently, we believe European banks present an attractive opportunity and have allocated 13% in HFG. Their ROEs (return on equity) have improved enormously in recent years but without the commensurate change in valuations (figure 3). While we generally expect banks with similar ROEs to trade at similar P/B (price-to-book) ratios, European banks currently have ROEs comparable to those of Canadian/U.S. banks but trade at much lower P/Bs (figure 4).
Specifically, European banks would need to appreciate by ~50% and ~70% to achieve similar P/B valuations as the U.S. and Canadian banks, respectively. Although we do not expect European banks to trade at par with their Canadian or U.S. peers, we are optimistic that the gap can narrow materially, which would support strong relative performance.
HFG – Strong Performance and Exposure to the Most Attractive Themes and Opportunities in Global Financials
The Hamilton Global Financials ETF (HFG) aims to provide Canadian investors with diversified exposure to the most attractive themes within the global financials sector while maintaining a volatility profile not materially different from that of Canadian financials. To achieve this, HFG focuses on a diversified portfolio (by country/region/sub-sector) of high quality global financial stocks with strong balance sheets, varied income streams and exposure to favourable medium/long-term cyclical trends.
Given its strong performance and its portfolio of high-quality diversified global financials, it is our view that HFG will continue to be an attractive complement to investors’ core Canadian bank/financials holdings.
Figure 1 — Global Financials are Quite Cheap Relative to Broader Markets
Figure 2 — U.S. Financials Remain at a Discount to the S&P500
Figure 3 — European Bank ROEs have Converged with Canadian and U.S. Peers
Figure 4 — European Banks Remain Attractively Valued
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[1] HFG’s total return from June 26, 2020, through March 28, 2024.
[2] As well noted in the financial press, CRE has seen its value decline with higher rates, and for offices, the trend toward working from home.
[3] As at March 28, 2024
[4] Source: Bloomberg
[5] As at March 28, 2024
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