FE Alpha Manager Alex Wright has made banks the biggest overweight position in his Fidelity Special Situations fund, saying that the return of capital to shareholders via dividends and buybacks should help the market to overcome the prejudice it has held towards the sector since the financial crisis.
The FTSE 350 Banks index is still down by 40.93 per cent from its pre-financial crisis high, but despite recent setbacks – including Brexit and the associated economic slowdown – a number of fund managers think the tide is finally turning for the sector.
Performance of index since financial crisis
Source: FE Analytics
For example, FE Alpha Manager Neil Woodford who has avoided the sector for the best part of 15 years added Lloyds to his CF Woodford Equity Income fund in June this year.
A spokesman for Woodford Investment Management said: “Despite the rehabilitation progress that the UK banks have made, share prices remain surprisingly close to the lows that coincided with the depths of the financial crisis in early 2009.
“Share prices tend to trade below book value too, which suggests that the stock market has yet to acknowledge the transformation of UK banks’ prospects that is now well underway.”
While Wright shares this view, he said the market could wake up to the value in the sector sooner rather than later.
“Valuations are attractive as they have been out of favour for some time, with most investors viewing banks as one of the riskiest sectors in the market,” he explained.
“This viewpoint is understandable, albeit one that I fundamentally disagree with. The trauma and aftermath of the crisis still dominates the collective imagination of the market, and seems to be preventing investors from recognising the profound changes that have occurred inside banks and in the external operating environment.”
Yesterday it was announced that, for the first time since the financial crisis, all UK banks had passed the Bank of England’s annual stress tests, which gauge their ability to continue trading in extreme market and economic turmoil.
Wright said such signs of strength are likely to change the consensus view towards the banks.
“Intense regulatory scrutiny means balance sheets are now generally much stronger than they have been for some time and the loans that are being written would seem to be much less risky than those made pre-2007,” he added. “Regulators are also now becoming more willing for banks to make sizeable distributions to shareholders in the form of dividends and share buybacks.”
Key positions in Fidelity Special Situations include Lloyds Banking Group as well as international holdings in Citigroup and Bank of Ireland, where Wright sees strong downside protection and the potential to deliver expectation-beating results next year.
In terms of the market as a whole, Wright said that while it can be difficult to predict its direction, the current high valuations mean investors should not expect the FTSE All Share to deliver the 10 per cent per annum returns it has managed since the financial crisis. However, one thing that he said would help support UK companies – especially domestically focused ones – is greater certainty over Brexit.
“Such clarity would provide a real-world boost to the domestic economy as it would enable firms to have more confidence when it comes to making operational decisions around investment and hiring,” he explained.
“This is probably wishful thinking and I expect markets are probably going to have to contend with a more uncertain and volatile backdrop, even compared with this year.
“From an investment perspective, however, this kind of environment would likely create some interesting stockpicking opportunities. Periods of macro-driven volatility tend to throw up valuation opportunities which are more difficult to find if markets are steadily trending upwards as we’ve seen over the last few years.”
When it comes to the sectors he is avoiding, Wright is pessimistic about the prospects for consumer staples due to the tightening of monetary policy.
“We’ve had 10 years since the financial crisis where steady businesses with stable cash flows have been in favour and this has driven strong growth in the share prices of areas like consumer staples,” he added.
“These types of companies have historically struggled in an environment of rising interest rates and we could now be at a point of change where the market may start to reassess the prospects of hitherto unloved sectors.”
Data from FE Analytics shows that Fidelity Special Situations has made 40.59 per cent since Wright took charge at the start of 2014, compared with 29.72 per cent from its IA UK All Companies sector and 30.68 per cent from its FTSE All Share benchmark.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
The fund is £3.2bn in size and has an ongoing charges figure (OCF) of 0.94 per cent.