Why are large investors returning to bank stocks now?

Fidelity, Wilmington among the institutions loading up on financial stocks.

Falling US Treasury yields are prompting a handful of large investors to load up on a perennially unloved corner of the stock market — banks.

Fidelity International Ltd. and Wilmington Trust Investment Advisors Inc. are among the fund managers adding exposure to lenders. The trade centers on the idea that short-dated yields will fall more than their longer-dated counterparts amid expectations of interest rate cuts next year. Such a scenario would boost banks’ earnings from lending as they typically borrow short and lend long, booking the difference in yields as profit.

The allocations underscore investor assumptions that bank stocks may outperform in the near-term as the equity rally broadens beyond mega tech. Lenders have lagged the market in 2023 — a year marked by an industry crisis that began in March and led to the collapse of Silicon Valley Bank.

“The natural conditions for financial businesses to do well — the upward sloping curve — is more within reach,” said Taosha Wang, a fund manager for Fidelity International. “It’s in the process of correcting something abnormal to something that is more normal.”

The Fidelity International Institutional Global Sector Fund, which Wang helps oversee, has almost a fifth of its assets in financial stocks, according to its most recent disclosure earlier this month. Its bank holdings as at end-August include JPMorgan Chase & Co, Morgan Stanley, Wells Fargo & Co. and Bank of America Corp.

Wilmington Trust, which has $78.5 billion in customer assets, has overweight positions in large and regional US banks, according to Tony Roth, chief investment officer, who declined to identify the specific holdings.

“The likelihood of a soft landing coupled with a drop in the front end of the yield curve makes things look pretty good for banks,” Roth said. “Many are also trading at fairly depressed values due to the bank crisis earlier in the year.”

The KBW Bank Index, one of the broadest measures of US lenders, is down 5.7% this year, while the S&P 500 has soared more than 23% — placing banks on pace for a second year of under-performance relative to the broader equity market.

The price-to-book ratio for the KBW Bank Index has recovered to trade near levels prior to the tumult in March, but sits close to its lowest on record relative to the S&P 500.

“The large financial institutions remain highly resilient,” Fidelity International’s Wang said. “If anything, there were inflows after the smaller bank incidents — that affirmed our view that large companies are well positioned.”