Falls in the value of shares in the UK banking sector are provoking a flight to safety by fund manag...
Falls in the value of shares in the UK banking sector are provoking a flight to safety by fund managers but are also creating attractive opportunities.
James Alexander, pan-European research analyst at M&G, says in the current climate, the largest banks offer the best protection against market volatility.
Across M&G equity funds, he notes, the group has an overweight position in UK banks, with the largest names in the sector making up a large part of that weighting.
Companies in which M&G is currently overweight include the Royal Bank of Scotland, Barclays and HSBC. These comprise three of the top four UK banks by weighting in the FTSE All-Share.
HSBC is the largest bank, making up 31% of the sector by market capitalisation, followed by the Royal Bank of Scotland, which comprises 18% of the sector, and Barclays, which sits in fourth position at 13%. M&G is underweight in the Lloyds TSB group, the third largest bank listed on the UK market, making up more than 13% of the sector.
The reason for M&G's caution on Lloyds is that, as a bank assurer, it carries an economic risk of bad debt and an equity risk caused by its life assurance subsidiaries, Alexander says. And while bank assurers are performing relatively well at the moment, he feels there is just too much risk associated with them.
The market perceives bad debts as the big issue for the banking sector as a whole, according to Alexander, but M&G believes it has been overplayed.
'The banks are much more profitable than in the last cycle and much less focused on lending, so bad debt is not as much of an issue,' he says. 'In the first cycle, bad debts doubled and eliminated 100% of the bank's operating profits. If bad debt doubles this time, it will only eliminate 50% of the operating profits.'
He adds that over the past two weeks, the banks have heavily underperformed the FTSE 100 index and M&G is considering moving further into the sector to take advantage of low prices.
One manager who has done precisely that is Mark Westwood, who runs the Legg Mason UK Growth fund.
He has had a heavily underweight position in the UK banking sector for the past six months, roughly 5% underweight, but the falls in share prices have tempted him to start moving towards a neutral position against the FTSE 100.
He is currently around 1.5% underweight the sector and has bought into the Lloyds TSB group, Barclays and the Royal Bank of Scotland. Lloyds and Barclays are both companies in which he did not have a holding until a month ago.
These stocks are attractive simply because they have fallen so far, he says. Lloyds has halved in price from £8 a share to £4 and the Royal Bank of Scotland has fallen from £20 to around £12.
'I would argue this is too cheap,' says Westwood. 'These falls are pricing in Armageddon.
Capital from cash holdings was used to take positions in the banks.
At present, Westwood's core holding within the sector has been HSBC as it is the most cautious lender among the banks and has a strong balance sheet, he says.
Attractive valuations in the market.
Banks more profitable this cycle.
Fundamentals still strong.
Bank assurers carry equity risk.
If US bad debts rise, UK banks will be impacted.
Percieved bad debt problem.
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