These issues highlight the seemingly never-ending macroeconomic challenges Europe faces, while low interest rates in particular make it difficult for banks to generate a return on their treasury operations.
A low-rate outlook is generally indicative of a challenging business environment, which suggests investors need to be selective. For instance, it is important to focus on dividend sustainability rather than the headline yield in isolation.
Biting back
Memories of the financial crisis are vivid and the current backdrop reinforces scepticism of the banking sector – a classic case of ‘once bitten, twice shy’. Banks are also viewed as complicated beasts with large, opaque balance sheets.
Despite these beliefs, there are two distinct approaches to unlocking value in the sector. One is to selectively seek contrarian recovery situations and the other is to invest in high-quality organisations.
The first approach involves investing in banks trading at distressed prices where there is scope, usually driven by catalysts, to recover to historical valuations. These types of investment tend to be underowned by mainstream portfolios.
One example involves the Italian banks. A recent change in legislation will force the local Popolari banks to become joint stock companies, which will give minority shareholders more voting power. Many observers believe this change could herald overdue sector consolidation, which will alleviate the excess capacity that has hitherto held back sector profitability. One or two of the listed Italian banks have already responded well to the prospect of M&A activity.
A question of quality
The second approach is to invest in higher quality banks with strong competitive positions and strong returns on equity. These banks have emerged from the depths of the crisis in positions of relative strength and are starting to deliver good capital returns.
Banks under this category include some of the UK, Benelux and Nordic banks. Some of these better quality names are becoming more widely owned by blue-chip funds.
How can investors best gain exposure to these opportunities? The Aptus Global Financials fund has exposure to both approaches summarised above. However, the genesis of the portfolio stems from continued rehabilitation of developed world banks and insurance companies that remain core to the strategy. Given this trade has almost played out in the US, with positive results for the portfolio, the developed exposure will likely have a tilt towards Europe going forward, as well as more stable financial services stocks with growing yields.
The fund is managed by Johnny de la Hey at Toscafund, a founding partner with extensive experience in managing financial services portfolios, and who is also lead manager of the financial services hedge
fund at Tosca. He heads an experienced team of sector specialists whose combined investment experience spans more than 70 years and includes John Sheehan, a dedicated insurance analyst with over 25 years’ investment experience.
There are one or two non-sector-specific funds that offer a more measured exposure to the sector. For instance, Neptune European Opportunities is currently significantly overweight financials. The fund is managed by Rob Burnett with a high degree of conviction.
Given the improving financial conditions in Europe, and the valuation opportunity, we expect this positioning to deliver favourable results in 2015.
