The increasing threat posed by the internet has left financials on relatively low valuations. Rather...
The increasing threat posed by the internet has left financials on relatively low valuations. Rather than see their share prices bouncing back, they may continue to head southwards as banks lose more customers to on-line operators.
Richard Peirson, manager of Framlington Financial unit trust, explains to James Thorneley why it is not all doom and gloom in the sector and why demographics and government policy mean there is a long-term future for financials.
Won't all financials struggle in the face of competition from the internet?
Entrusting your savings with a new on-line operator is a lot different from buying a book from Amazon.com. The threat of the internet is not as great as implied in the prices of traditional banks. Europe and the UK are about two years behind the US in terms of on-line banking, and in the US there have been no major inroads made by online operators. Internet banks from new entrants have been slow to get off the ground.
In addition it will be incumbent businesses which are likely to benefit rather than newcomers to the market. Egg has been very successful, but you can class it as an incumbent because of its links to Prudential, and without the Pru it would not have enjoyed the success it has. Barclays is the leader in IT among UK banks and has already got 600,000 on-line customers. LloydsTSB has been slower off the mark and has been criticised for this, but it will catch up quickly.
If newcomers to online banking are going to be relatively unsuccessful, what about online brokers?
In the US, online brokerages have been very successful so far, and we have invested in a number of European operators. But these companies will not be able to maintain this success over the longer term. The profit margin of on-line dealers is very narrow, and they are gradually realising that they need to offer more than one service.
Pure on-line dealing will not be particularly profitable and should become a commodity area. Recently, Charles Schwab bought US Trust, a fund management group. It recognised that it needed to provide more rounded services.
The internet is interesting because we are focusing on businesses which have creditable internet strategies. We favour companies which are looking to develop their business rather than defend it. Countrywide Assured has recently launched a website for the sale of property. Interactive Investor is also attractive. We bought into it when new shares were issued last month. The shares were priced at 150p and jumped to 450p, when we sold. They have now come back to trade at slightly above the issue price, when we have bought in again.
There has been a lot of consolidation among financials in Europe. Will this continue and will corporate activity increase in the UK?
There is much more interest in the consolidation story in Europe than in the US, where investors have become jaundiced about consolidation as a number of mergers have not worked out. In the UK, we have become much more jaundiced about consolidation in the same way as they have in the US.
Most of the acquisition targets in the UK over the past few years we have held in the portfolio. Another one of our holdings, St James's Place, was bid for last week by the Halifax. We also owned a very small group called IE, an IFA network, which was bought by Misys. We recently bought Norwich Union which has not produced much upside as yet, but in combination with CGU there is a lot of potential there.
What effect will the impact of stakeholder have upon the fund?
One reason I hold Legal & General is because I think beneficiaries of stakeholder will be few in number. You need scale and highly rated technology to cope as the margins are likely to be small. In general, it will not be a major bonanza for the industry.
Looking at your asset allocation, is it very dominated by the UK and Europe?
The US market has underperformed, and so currently we prefer to play other regions of the world. We have been positive about Europe for two reasons. Over the shorter term, industry consolidation will continue as businesses try to create scale to compete in the larger European market place. If you are a big French bank you are no longer protected in your domestic market, and you need to compete globally.
The long term story is demographic. If you look at pension provision costs to European governments they are rising much more rapidly than anywhere else in the world. It is a fact that benefits within Europe will be reduced, forcing people to save more.
On top of that, you have the birth of an equity culture in Europe which has been long established in the UK and the US. Previously, Europeans invested their surplus income in bank accounts and bonds. They now recognise that is not very sensible, and equity is an attractive option.
The managements of European companies have become more shareholder friendly. Previously, shareholder interests were not a priority for managements. They were more concerned with their own jobs and about the banks they borrowed funds from rather than profitability.
In the UK there are some attractive niche businesses which have been performing better than their large cap peers.
Is an equity culture beginning to surface in Japan with post office savings accounts matur-ing?
The Japanese do have an equity culture but they are nervous because they remember problems experienced in the aftermath of the bull run of the 1980s. Also, there is an enormous lack of trust in the banking system but there will be opportunities over the next few years. There is a larger amount of unmanaged money in Japan than anywhere in the world.
Most individuals have money on deposit. Some hold cash because interest rates are so low. The Japanese do not trust banks and brokers but we are seeing a big bang in the way financial institutions operate as we saw in the UK in the 1980s.
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