Fund groups bet on banks in the search for income

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With an interest rate hike looming and the regulatory shake-up experienced in the last decade complete UK banks are now set to be one of the best performing sectors for 2016, managers say.

Financials are expected to be the strongest-performing sector in 2016 in terms of both profits and dividends, according to data gathered by AJ Bell, analyst views and web financial group Digital Look.

Thirty per cent of 2016 profits and 24 per cent of dividends for the FTSE 100 are forecast to come from financials, according to the research.

In terms of dividend growth, financials are also predicted to lead the way, representing 50 per cent of the expected increase.

AJ Bell investment director Russ Mould says banks may be the “most surprising” contributors to dividend growth next year.

He says: “Our research shows that one-fifth of the expected profit increase for 2016 is expected to come from the big five banks – Barclays, HSBC, Lloyds, Royal Bank of Scotland and Standard Chartered.”

He expects Lloyds, HSBC and Barclays between them will generate 42 per cent of the FTSE 100’s forecast aggregate dividend growth.

Architas senior investment manager Nathan Sweeney says banks have been “almost universally” unpopular stocks for many years but now their outlook is more positive.

He says: “Banks have had to cut costs and rationalise, rein in their international operations and return to focus on their core businesses. This has put them collectively on a much stronger footing.

“Given the problems across other areas of the FTSE from resources and commodities, there is a good chance people will start to hide in big stocks perceived to be resilient.”

The long-awaited interest rate hike from the Bank of England would also be a turning point for banks to raise capital, experts say.

BlackRock fund manager Mark Wharrier, who runs the £350m BlackRock UK Income fund, says UK banks will benefit from the interest rate rise as they have not been able to make money from their deposits. “Rates start to flicker into life and [UK banks] is one of the few sectors that benefits from that,” he says. “People often forget about that because it has been so long since we had a raise.”

Wharrier has recently bought HSBC in the fund and added exposure to Barclays and Lloyds. The three make up 10 per cent of his portfolio.

He says: “It’s an area where we are buying on a medium-term view. Everything that could have gone wrong for banks has gone wrong in the last decade but you are now in a position where capital ratios have been increasing to 12, 13 and 14 per cent.”

Rob James, banking specialist in the UK equities team at Old Mutual Global Investors, is overweight the financial sector and in particular banks that “are able to restructure themselves”.

He says: “The capital rules have changed to such an extent that the business banks were doing before would be economically unviable today.”

The industry has welcomed the Government’s sale of £2bn of Lloyds shares announced in October as ideal for those using pension freedoms and for first-time investors.

The bank is likely to become a solid dividend payer, says Hargreaves Lansdown senior analyst Laith Khalaf, who expects the lender to yield 3.5 per cent this year and 5 per cent next year.

However, experts do not have the same positive outlook for other big banks in terms of dividends.

Sweeney adds: “Lloyds is also visibly improving its cashflow, which has very much been a theme of the last few years. However, the market is less convinced about Barclays, with uncertainty about the new chief executive, low return on equity and no excess capital.”

Jupiter’s Alastair Gunn, co-manager of the Distribution Fund, says costs for UK banks have been too high for this results season and have been “disappointing”.

He says although dividend growth expectations from many of these banks were higher this year, he is hopeful as “there is definitely more capital available for these businesses”.

Gunn says he has always held HSBC but has recently added Barclays, which makes up 7.1 per cent of the fund, as well as Lloyds and RBS, at 7.5 per cent and 4 per cent.

Experts are hopeful the Government might soften bank regulation, enabling them to have enough to pay dividends, but there is more that banks need to work on at a time of slower economic growth.

Gunn says: “Over the last five years bank capital rebuilt substantially because they had to pay fines, but we are getting closer to the point where regulators are not squeezing any further.”

Banks are also going to have to “work hard” to increase their earnings substantially, says Mould, who adds: “Without progress from the banks, the FTSE 100 may find it a stretch to dash past the 7,000 mark once more.”