“The valuations are modest but the million dollar question,” according to Romney Fox, an investment manager at Aberdeen Asset Management, “is when will the sector go through the process of de-leveraging, generate sustainable profitability and return on equity. It is a good time to buy when you think the business is fit for purpose but I do not think we are there yet. The UK banks have the weakest returns and they have a long way to go.”
Positive direction
Not everyone though is as bearish. In May, Deutsche Bank strategists published a note favouring the banking and financial sector, on expectations that cyclical stocks – those most sensitive to the state of the global economy such as banks – will outperform more defensive sectors as the economic environment improves.
They believe, that, “the European equities rally earlier this year was led by defensives, not cyclicals – which we expect will benefit most in an equities re-rate. Within cyclicals, we expect financials to be the most attractive sector as the implied cost of equity is now retracing mid-crisis levels, and a positive credit impulse surprise would benefit banks the most.”
The German bank recommends building up exposure to a possible rally in European bank stocks by buying futures contracts on the eurozone’s Euro Stoxx 50 bank index and on the broader pan- European Stoxx Europe 600 Banking index.
Matthew Beesely, portfolio manager, head of global equities at Henderson Global Investors, on the other hand, favours a more stock selective approach. The fund manager’s concentrated global equity portfolios are home to 30-40 stocks each, where the aim is to generate at least a 50% absolute return over two to three years. Currently, 25% of the portfolio is in financials against 20% in the MSCI World benchmark. Favourite banks include Lloyds Bank, Citigroup, KBC Groep, Standard Chartered, Halk Bank (Turkey), Sumitomo Mitsui Financial Group and Bank Mandiri (Indonesia).
“Lloyds Bank, KBC and Citigroup are trading at discounts to their tangible equity base,” Beesely says. “We think this is an anomaly when you consider their ability to earn returns in excess of their cost of equity and to re-deploy excess capital generated either into their domestic markets or back to shareholders.”
Andrew Parry, CEO of Hermes Sourcecap, is also discerning. “Slightly healthier economic growth in North America is helpful to US banks, alongside lighter touch regulation. Asian banks meanwhile can benefit from the fast growth ASEAN market. However, on standard metrics both the US and Asian banks are more expensive and at a stock level there continues to be interesting opportunities.”
As for Europe, Parry believes that the global financial crisis has forced banks to change. “No longer able to just leverage up the balance sheet, companies adopted different strategies and contrasting business models emerged. This presents opportunities for stock pickers as there is now increased differentiation at a company level and the sector is no longer a top-down call. For example, companies like Bank of Ireland have risen 50% year to date, while other Euro Stoxx members such as Commerzbank have fallen 28%. We believe balance sheet strength will continue to reward investors and thus favour well-capitalised banks like Swedbank with low leverage ratios.”
Looking ahead, Parry believes, “the continued impact of regulation and political interference provides the biggest challenge for bank investors. These factors take an unpredictable course and such is their importance they often have a disproportionate impact on bank shares relative to the fundamental underlying progress of these businesses.”
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