Investment Focus: Financials
Why the 'Boring' Financial Sector is Outperforming Tech in 2025
Technology may be seen as the glamour sector, but ‘boring’ financials have given it a run for its money over the past year. The financials sector has outpaced the technology sector by around 14% in the past 12 months.[1]
The diverse landscape of financial services
The financials sector is the second-largest globally after technology. While it tends to be conflated with the banking sector, it is far more diverse than this characterisation suggests.
Banks make up around 37% of the MSCI World Financials index, but it also holds insurance companies (20.5%), capital markets businesses, such as stockbrokers and asset managers (20%), along with payment companies, consumer finance groups and specialist mortgage providers.
MSCI World Financials Index - Industry Weights, correct as at May 2025.
Even within the banking sector, there is considerable variety. There are the traditional high street banks, which focus on retail customers, but there are also commercial banks and investment banks. JP Morgan Chase or Goldman Sachs have a notably different profile to, say, Barclays.
The banking sector will also include emerging market banks, such as HDFC Bank or ICICI Bank in India. These will often have a very different profile to more complex and diversified developed market banks, and may be geared towards economic growth in these regions.
How macroeconomic forces shape financial performance
Nevertheless, the financials sector is often seen as uniquely sensitive to macroeconomic forces. The fortunes of the banking sector, for example, will often be related to interest rates, though the transmission mechanism is nuanced.
Banks make their money on the spread between the interest they pay on deposits and the interest they earn from lending. That’s why people tend to pay more to borrow than they receive on their savings. The theory is that if interest rates move higher, banks can increase their profits because it is easier to widen the gap between the interest paid and interest earned.
This visual is for illustrative purposes only. Actual interest rates and spreads vary by institution and economic conditions.
However, it is not a straightforward calculation. While very low interest rates certainly make it difficult for banks to make money, banks may put hedging in place to deal with rate cuts. Equally, banks don’t necessarily get an incrementally better return for every rise in interest rates. Interest rates are also important for insurance companies, which tend to have large cash balances that they need to set aside for liabilities. If they can earn more interest on that, it helps their earnings.
This has been an important factor in the strength of the banking sector over the past 12 months.
The rise in interest rates in the last two or three years means banks and insurance companies, in particular, are making much more attractive returns. Their profits have improved, and we think that trend is going to continue, because we don’t see interest rates going back to the levels that we saw four or five years ago.
The growing influence of payment systems and capital markets
The payments sector is also important within financials. Two of the largest companies in the index are Visa and Mastercard. Macroeconomic factors are also important for these companies, with economic activity driving more transactions. Increasing digital payments and the companies’ ability to expand into emerging markets will also shift the outlook for returns.
For capital markets companies, the swing factor will be financial market activity. Exchanges, such as the London Stock Exchange or Deutsche Börse will do well out of market volatility. For example, in its latest update, the London Stock Exchange said:[2]
Our Markets division saw strong broad-based growth against a backdrop of elevated volatility, which has persisted into April, reflecting continuing uncertainty around the outlook for financial markets and the global economy more broadly.
Asset managers will generally do well out of buoyant markets, though it depends to some extent on the balance of their business. If companies have a large fixed income franchise, for example, they might do well at times when investors are worried about stock markets. There will be other factors, such as the balance of active versus passive in the market. Changes in tax-incentivised savings from governments can also influence flows for these companies.
Long-term trends driving the financials sector
Digital transformation in finance
A number of long-term trends could drive the financials sector from here. In particular, many financial companies from insurance, to banking, to wealth management, have embraced the digital revolution.
The digitalisation of banking, for example, has been a sea-change, with consumers now well-versed in managing their savings and investments online. At its heart, the digitisation of banking is simply the ability for users to access financial data online through desktop and mobile devices. However, its implications for the sector are far wider. It enables banks and financial institutions to hold and analyse client data. This can help them run more efficiently and understand their customers better.
New, digital-first players such as Revolut have come into the market and shaken up incumbents. Many of the major banks have managed to keep up, either by developing their own technologies or by buying these new players. Nevertheless, the sector is likely to become increasingly polarised between those financial players who can harness technology effectively and those that cannot. The biggest banks in the US are now spending over $10bn each annually.
The digitalisation trend may have started out with banking, but has spread to wealth management, currencies and stocks and shares trading. Insurance companies have been able to streamline underwriting, improving pricing and risk analysis.
The evolving regulatory landscape
Over the past 15 years, there’s been an enormous increase in the amount of regulation that impacts the sector, with rising capital requirements and costs.
That’s quite understandable, because there was a lack of regulation in the run-up to the global financial crisis. We would argue that the pendulum has swung from too little to too much. We’ve started to see, especially in the US but also in Europe, steps being taken where that pendulum is going to swing back a little bit from where it is today. The sector’s still going to be very highly regulated, but a more constructive relationship with regulators, a more balanced approach to the issue, is a positive tailwind for the sector.
This may end up being an important factor for the sector. Donald Trump promised banking deregulation “on day one” in the US, but has found other priorities. He is starting to talk about it again now, and careful deregulation would certainly be welcomed by the sector.
Future outlook and investment potential
While there are nuances to how individual financial sectors perform, it is generally a sector that does well at times of economic expansion. For the time being, its strength hasn’t been disrupted by the fears of a global economic slowdown in response to Trump’s tariff war. The MSCI Global Financials index is unmoved as at the end of April, compared with a fall of 7.1% for the wide MSCI World index.
MSCI World vs MSCI World Financials, YTD
Source: FE Fundinfo, correct as at 20 May 2025.
Until recently, the sector had struggled to shake off the legacy of the global financial crisis, even though the measures that were brought in in the wake of the Financial Crisis have raised standards across the banking sector. This has meant that the sector has traded more cheaply than its peers. This continues to be the case even after the recent rally.
Financial companies are the largest constituent of value indices, reflecting that many in the sector trade at lower price-to-earnings or price-to-book multiples and/or higher dividend yields than the wider equity market.
The interest rate cycle is turning, which may not naturally favour the financials sector, but interest rates are unlikely to revert to the 1-2% levels seen after the Financial Crisis. There are a range of long-term, helpful trends for the sector, including digitisation and deregulation.
How to invest in the financials sector
There are a range of active and passive options to take direct access to the financials sector. Jupiter, for example, has a dedicated Financials fund, the Jupiter Financial Opportunities fund, as does Polar Capital, the Polar Capital Global Financials Trust. Active funds can be more flexible in terms of the interest rate cycle, varying their exposure to banks, for example.
There are also a range of ‘financial innovation’ funds, which provide access to smaller financial companies and digital-first companies. These include funds such as the Jupiter Financial Innovation fund or investment trust Augmentum, which has financial groups Tide, Zopa Bank, Volt and Grover among its top holdings. The holdings in the Augmentum portfolio are private companies, rather than publicly listed, which carries more risk, but allows investors to buy in at an earlier stage.
Fintech continues to offer investors exposure to innovation and disruption, representing a 3/2 share of the $14 trillion global financial services market. Startups from across the fintech sector continue to prove their ability to adapt quickly, stay resilient, and even outperform traditional players during periods of macroeconomic uncertainty, underscoring their long-term potential in both stable and volatile markets.
There are also a range of dedicated financials ETFs, including the iShares MSCI World Financials Sector ETF. These will tend to have high weights in the US – over 50% - with 5-6% in each of Canada, the UK, Switzerland, Germany and Australia. There are also dedicated European or US ETFs. One quirk to note is that the largest weighting in the global indices is usually Berkshire Hathaway, the investment company managed by Warren Buffett. With Buffett set to retire this year, there may be a bump in the share price.
Investors can also get access to the financials sector through active funds with a higher weighting in the sector. The Man GLG Income fund, for example, has significant holdings in the banking sector with HSBC, Barclays and Lloyds among his top 10 holdings. Manager Jack Barat says many of the issues for the sector have fallen away in recent years and there is now a supportive interest rate environment.
Conclusion: A key component in a balanced portfolio
Financials have an important place in a portfolio. They can be a natural place to invest as interest rates are rising, but also when economic activity is increasing. There are also supportive long-term trends for the sector as it embraces technology and regulation shifts.
---
[1] MSCI World Financials and MSCI World
