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The recent rise in yields has boosted the performance of financial credits, the subordinated segment in particular. The insurance sector in particular can act as a great hedge for further rising yields, if and when this occurs.
Sentiment towards the financial sector has clearly improved since the summer of this year. Since then, financials have outperformed corporates. One of the key reasons financials continue to trade so well is the increase in interest rates and the steepening of the yield curve. This improves the earnings outlook for both banks and insurance companies, as they can benefit from higher margins. Robeco Financial Institutions Bonds has an overweight in both. Around a third of the portfolio is invested in bonds issued by insurance companies with the remainder being invested in banks.
CoCos have also performed well over the past few weeks. A driver of their positive returns is that some banks have now disclosed their Maximum Distributable Amount (MDA) trigger levels for next year. These are the levels at which coupons have to be canceled. The levels for next year are lower than the current levels, lowering the risk of coupon cancelation. For example, the trigger level for ING changed from 10.25% to 9% for next year, for BBVA from 10% to 7.625% and BNP from 10% to 8%. Although this was to some extent reflected in valuations, the actuals still made Cocos outperform. As per the end of November, we have an allocation to this category of around 9% (approximately 5% in AT1 CoCos and some 4% in tier-2 CoCos). This percentage has slightly declined as we have taken profit on some holdings after the recent strong performance.
With limited primary issuance in the past few weeks we have seen positive price performance in the secondary market, benefiting the total return of this sector and the fund.
Given the improved prospects for insurance companies, we have further increased our weight in this segment. We bought Aegon, for example, which has good exposure to the US. In this country, interest rates have risen more than in Europe, benefiting US banks and insurance companies. We further expanded our US exposure by participating in two USD issues of US banks. We expect that European financials will follow the move tighter that we saw in US financials.
As the interest rate environment is becoming more favorable for the financial sector, we remain optimistic on the return outlook, even after the recent outperformance. Steeper curves will benefit banks and higher long-term yields will be good for insurers. The insurance sector in particular can act as a great hedge for further rising yields, if and when this occurs.
The fact that third-quarter earnings for the sector were generally better than anticipated reflects the good environment for loan quality in most countries, although specific issues still exist in countries such as Portugal and Italy. Finally, regulatory pressure for banks seems to be easing, which is good for the subordinated segment in which we invest.