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Bank notes

Banks have certainly not been absent from headlines of late but one area where they have definitely not been seen is in the factsheet of too many equity funds.

But if the share price of banks are at unbelievable and historic lows, what exactly is stopping fund managers from holding them? Normally, when stocks are depressed to such lows, managers rave about the buying opportunity they present. Not so with banks, as uncertainty reigns and the risks still appear too great.

That being said, being out of such a huge part of the UK equity market also poses a risk – particularly if banks rally, as shown by the more than 20 per cent rally in the share price of RBS on February 26 after it announced its involvement with the Government’s new asset protection scheme. The rally also came after it reported the biggest-ever annual corporate loss in UK history – £24.1bn.

It is unpredictable events such as this that has turned the volatile banking sector into a very tricky call for UK managers. The depressed share price of the UK’s troubled banks is keeping fund managers wary of exposure in this area despite the potential for huge upside. Some managers say investing in banks is like an option trade at the moment – the investment could be worthless or make a massive gain.

As such, until some certainty and stability returns to the sector, many are avoiding taking too big a stance. Finding managers who speak confidently about opportunity in the sector is difficult to find although, notably, Odey Asset Management founder and fund manager Crispin Odey has been widely reported as moving long on UK banks in recent weeks.

Clive Hale, an independent investment consultant, agrees that while there may be huge upside to be seen in these stocks, the ability to get it wrong at this time is also huge. “Managers do not like uncertainty, they will want to see stability in this sector before they start to buy in,” he says.

Fidelity enhanced income manager Michael Clark, who worked in Sweden in the 1990s during its banking crisis, says it is difficult to predict exactly what will happen in the UK. “Banks priced at 20p a share – do they go to nothing or rise to £1? It is difficult to tell at this time,” he says.

Tim Russell, fund manager of Cazenove absolute target fund, says: “There is a big difference between low prices and low valuation.” With banks still owning up to the losses and bad debts on its books, as evidenced by RBS’s £24.1bn loss, it is difficult to tell at what level banks would represent good value.

“Banks could double or halve again from the levels they are at today. The valuation of these equities is very difficult at the moment.” Banks offer no yield and the p/e ratios of these companies is hard to ascertain, as is the impact and influence from of the Government’s participation in the sector, he adds.

Russell has some financials’ exposure in his fund, although he prefers insurance firms over banks. He has taken a stake in Barclays, believing it is worth paying for a bank that has escaped the Government’s influence.

Nationalisation may be the final safety net but the Government appears to be doing everything it can to avoid such a scenario, not wanting to assume the problems associated with these companies. Clark does not believe it will become necessary for nationalisation but Neptune head of European equities Rob Burnett does not believe such a move should be ruled out entirely. Neptune’s financials team, of which Burnett is a member, notes: “We are of the opinion that fears of nationalisation are currently quite justifiable.

“To call banks cheap at this level is misleading – they are more likely to trade on the ongoing delta of bad news and on responses to and perception of Government action. It remains our view that the realpolitik of the situation demands increasingly dramatic policy measures be taken to break the current deadlock in the banking system, given that credit is the lifeblood of the real economy. What exactly this action will look like is hard to say but de facto nationalisation is the ultimate outcome and until we have any visibility on how this end game plays out, the risk reward is still skewed firmly against owning the banks.”

Long-only managers dealing with the banking sector face a difficult call. The risks of being involved in an uncertain area are complicated by the risks of being out of such a big part of the UK market if and when the sector finds its feet and moves upwards.

Russell’s Europe equity colleague Chris Rice notes that the fortunes of the banking sector are at the heart of most markets. He says: “The market can only go up if the banks do but what will pull them up? Investors discovering value in these stocks or the government taking them on?”

Rice says in Europe, managers are favouring a bank weighting of 0-3 per cent, a significant underweight position in a sector that makes up some 12 per cent of the market. He says it is becoming a risk to be too far outside this area and he is seeking out opportunities. Of the EU banks, he figures some 30 per cent have a proper p/e while the remaining 70 per cent are trading as options as sentiment has led investors to disbelieve that they have sufficient capital to survive.

Volatility in the banking sector is unlikely to abate any time soon, considering the myriad of factors affecting the companies. Considering the size, weight and sentiment attached to UK banking stocks, fund performance and stock selection among managers is going to be heavily influenced by the day-to-day swings that are occurring not only in price but in the news as well.

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