Above market yields and low valuations are making the financial sector attractive to income managers...
Above market yields and low valuations are making the financial sector attractive to income managers.
John Hatherly, head of global analysis at M&G, says it is best to split the year to date into two to analyse the performance of income funds.
The average income fund performance for the six months to 30 June was -1.7% while the All-Share fell by 5.5% on a total returns basis. In the three months to 30 June income fund average performance was 2.8% while the All-Share returned -2.1%.
Financials are a major part of the market, taking up 22% of the index. Average yield for the sector in 1999 was 3%. Hatherly says: "When you look at the yields on financials you are talking about substantially higher returns than the market average."
The average yield for banks in 1999 was 3.3% while insurance firms provided 3.1%. Expectations for dividend growth among financials for 2001 are 11%, outstripping the market average expectation of 8.6%, he says.
With the dividend stream from financials so high, Hatherly expects the sector to provide a large proportion of income even though the stocks generally remain out of favour.
Hatherly says he has mixed views on financials and, while bad news may already be factored into the price of bank stocks, he believes insurance firms may provide better prospects for income investors.
He says: "This is the period in which virtually all the banks announce their profits and dividends and there is the general suggestion that banks' profits will not grow although they are in a healthy enough financial state to maintain high dividends."
Kenneth Warnock, fund manager on Jupiter's Enhanced Income Investment Trust, says he has been very negative on the banking sector in the past 12 months but is now finding them attractive again. He says: "We are beginning to see some value, especially on mortgage banks, which have come under heavy margin pressure."
Warnock says HSBC's mortgage cutback on standard variable rates for new and existing, or backbook, clients has created a problem for its bigger rivals, such as Woolwich and Halifax.
Backbook business within these groups as a percentage of their business stands at around 30% and 40% respectively.
He says: "If they follow HSBC's example and lop 1% off what they are receiving in backbooks it would take 20% off their profitability."
Bad news is already priced into bank stocks, however, with return on equity high at around the 18-20% mark, according to Warnock.
He says: "If you look at prices, the stock market is telling us these banks will never be profitable again.
"If you take Abbey National as an example, return on equity is around the 21% mark and, if they reduce their standard variable rate by 1%, it will drop to 19% yet the share price says return on equity is set to drop by 11%."
Warnock believes historical data indicates this would not be a bad time to get into the market with bank stocks and he has been actively buying Abbey National and Woolwich shares.
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