This article was originally produced in conjunction with Boring Money for their Insights.
Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved makes any express or implied warranties or representations.
After a period of strong returns, a careful fund manager will recalibrate and ask whether valuations accurately reflect a company’s growth prospects. For investors in global financials, it is an important question after a year when the sector has outpaced the majority of its peers, including technology.
The MSCI World Financials Index is up 25.7% over the past year, more than 10% ahead of the MSCI World Index1. Low starting valuations, high yields and a benign interest rate environment have all helped lift the sector to new highs. However, this strength has persisted for some time, and investors may be asking whether it can continue, particularly in the face of lower interest rates and a more uncertain economic climate.
Source: FE FundInfo, 14 October 2025.
Nick Brind, co-manager on the Polar Capital Global Financials Trust (PCFT), says that it can, but with some caveats. While he is reassured by the stronger capitalisation and risk management from all banks and insurers, he believes there are areas where returns look likely to be more hard won from here. For him, the contrasting fortunes of the European banking and European insurance sectors illustrate the team’s thinking and demonstrate the importance of an active approach.
European banking sector
It is perhaps understandable that investors are nervous over European banks, which have been among the strongest performers in a top-performing sector. The MSCI Europe Banks Index is up 60% over one year, compared to just 9.3% for the MSCI Europe Index2. The Index is up 52% in 2025 alone. This would give any value-driven investor pause for thought. PCFT has been invested in the banks and participated in the rally, from behemoths such as Italy’s UniCredit and Austria’s Erste Group, to smaller banks such as the Bank of Cyprus, which is a beneficiary of the buoyant Cypriot economy.
Brind points out that second quarter earnings were positive, and most banks delivered a favourable outlook. Net interest income (the difference between the money banks make on loans versus what they pay out for deposits) was particularly strong. Investors may be nervous over whether banks can repeat this success from here, particularly in a climate of lower interest rates.
The European Central Bank has already cut rates several times – the main refinancing rate has come down from 4.5% in May 2024 down to its current level of 2.15%. Investors may be worried that it makes their current run of strong earnings more difficult to sustain. A recent European Parliament study found that European banks are especially sensitive to interest rates compared to U.S. peers, with net interest income making up 60% of net operating income.
Then there are the worries over the global economy. Economic weakness created by the impact of tariffs could potentially force banks to raise their provisions for bad debts. Even if the global economy appears to be on an even keel today, the impact of tariffs and shifting supply chains is only just starting to be felt.
Yet, PCFT remains overweight European banks and believes they have further to run. Brind points to a number of factors driving their support for the sector. In particular, valuations are still very attractive. The aggregate price to earnings ratio for the MSCI Europe Bank Index is just 10x (or 9.4x on a forward P/E). Price to book is just 1.3x, while the dividend yield is 4.6%. The wider European market is not particularly expensive compared to the US market, but it still has a P/E of 16.8x3. While the gains from European banks have been giddy, there is still scope for further re-rating as evidenced by the pickup in bank merger and acquisition activity (M&A).
So there is still some optimism that banks can maintain their current run of strong earnings in spite of falling interest rates. According to Reuters, Morgan Stanley analysts said second quarter earnings supported a view that net interest income has bottomed sooner than expected and that growth should resume in 20264.
Interest rates are low, but not that low. ECB interest rates may have fallen from their peak, but they are not expected to drop significantly from here, particularly now that a tariff deal has been agreed. Banks are arguably in a ‘sweet spot’, where profitability is still very good, in part as they are not having to deal with significant corporate stress.
Brind says: “Higher interest rates should also help the sector sustain significantly better returns than in the decade following the global financial crisis, when investors became numbed by negative interest rates and therefore much weaker profitability, which we believe is still not reflected in current valuations.”
M&A activity could drive further consolidation
There also remains the prospects of further M&A activity in the sector. Oliver Wyman reports that $27 billion in European banking deals have been announced since the start of 2025, almost double the volume for the same period in 2024. Europe's banks are generating substantial excess capital and as share prices have risen, M&A may make more sense than continued share buybacks.
There are tentative signs already. BBVA has declared its interest in Spain’s Sabadell, while UniCredit has built up a significant stake in German’s Commerzbank as it pushes for a tie up. Cross-border banking M&A in Europe still faces political hurdles, but UniCredit may prove a trailblazer in this type of deal. It has already bought Aion Bank and Vodeno and offered to buy Banco BPM. The European Central Bank has made clear its support for cross-border mergers to build larger, more competitive European banks.
The Polar Capital Global Financials team also believes the European banking sector should be a beneficiary of the growing largesse of European governments. The German government has committed to €1 trillion in spending on infrastructure and defence. It is set to run a budget deficit of around 3%5 next year. This is a marked departure from the fiscal rectitude that has characterised German economic management. Banks will be needed to help fund this spending, but should also benefit from any knock-on economic growth. Brind concludes: “The portfolio continues to be overweight European banks where we think valuations still do not reflect the attractive returns on offer.”
Caution on the reinsurance sector
However, he adds: “one area that has done very well where we have become more cautious is on the global reinsurance sector.” Like the banking sector, it has been a source of strong returns over the past year, up 23.1% for the year ahead, over 10% ahead of the wider MSCI Europe Index. While there is still a lot to like about the sector, Brind believes a period of strong profitability may be drawing to a close.
Brind adds: “Over time, this record profitability is likely to put pressure on (re)insurance prices and curb future returns as excess capital needs to be deployed or returned to shareholders. We recently met with several US insurers at a conference in New York City and management teams rightly point to the high level of absolute returns they are able to generate.
“However, markets are particularly focused on the direction of travel and, despite strong Q2 earnings, the share price reactions have been more cautious. We have been repositioning our portfolio away from companies with exposure to areas where pricing pressure is most intense.” PCFT recently sold its position in Swiss Re due to concerns on increased competition in property and casualty reinsurance.
Overall, Brind and his colleagues remain positive on the financial sector in spite of its recent run. He adds: “Despite the strong performance of banks and the wider financials sector, we think it is important to remember that valuations across the sector remain reasonable compared with wider markets.” There is the need for greater selectivity, but until the past year, the sector had been widely unloved.
He concludes: “We believe financials offer a compelling way for investors to access a sector with strong fundamentals at attractive valuations and to diversify their existing holdings in higher growth sectors where equity markets remain very concentrated.”
1. https://www.msci.com/documents/10199/255599/msci-world-financials-index-net.pdf
2. https://www.msci.com/documents/10199/e72ea9be-ae79-4bb5-8ce0-054d4f371549
3. https://www.msci.com/documents/10199/e72ea9be-ae79-4bb5-8ce0-054d4f371549
4. https://www.reuters.com/sustainability/boards-policy-regulation/inside-european-banks-stellar-run-towards-or-beyond-sweet-spot-2025-08-29/
5. https://economy-finance.ec.europa.eu/economic-surveillance-eu-economies/germany/economic-forecast-germany_en
