InvestmentsOct 22 2014

Digenan bets on growth of financials heavyweights

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US equity manager Tom Digenan has said he is backing major US financials instead of smaller rivals, which he claims are too expensive.

The manager – who runs $7bn for UBS Global Asset Management, including its £224m US Equity fund – said that while he has an overweight position in financials he has avoided regional banks because he believes their high share prices are unwarranted.

Mr Digenan said he prefers major banks such as Citigroup and JPMorgan – both of which are in his top 10 holdings – as well as Morgan Stanley. He also has stakes in major financial companies American Express and Capital One.

The manager said his support for large banking stocks is based on his belief that the businesses are improving and will be able to grow their earnings, rather than it being a call based on whether interest rates will rise, which is a tailwind for banks.

“Regional banks are trading at a big premium, whereas Citigroup is trading at 0.9x its tangible book value. If you believe the businesses will be able to return capital, it is an earnings growth story. I understand the story behind the regional banks, but the valuation level is not there and people are paying too much of a premium,” he said.

The move echoes that of other US equity fund managers – including Legg Mason’s Sam Peters, who took on veteran investor Bill Miller’s Value Trust in 2012.

Mr Peters told Investment Adviser in April that he thought financial companies, especially banks, had been so beaten up and overlooked by investors in the crisis that it would only take a small earnings improvement to generate significant returns.

At the time, he had placed financial services giant Citigroup among his biggest positions, citing the potential for “a gargantuan home run” if the firm breaks up and parts of it are sold.

In the past year, Citigroup has been broadly flat. In October 2013, shares were trading at $48 per share; last week, they were trading at $50.1 per share, according to Bloomberg.

Mr Digenan said the big banks had balance sheets that are “as clean as they have ever been” and that the companies have “not issued a bad loan in five years”.

Elsewhere, the manager said he “does not see a lot of animal spirit” in the consumer, in spite of his opinion that the population is “poised to spend, as their balance sheets are pristine and debt is low”.

“In Q3, the only thing people bought was an Apple iPhone, so the Christmas season will be interesting,” he said.

The manager said a key issue is the fact there has been a lack of wage growth. However, he said he sees “pockets” of the economy where wage cost pressures are mounting.

“There are pockets where we are starting to see wage cost pressures, which will be positive for the consumer,” he said.

“There is a labour shortage in trucking, and some pockets of construction, which I would not have expected.”

The US bank play

Financials is a sector more and more US managers are keen to put money behind.

The majority of problems are already either behind it or being dealt with. The quality of banks’ loan books is improving and, as far as can be assumed, the mega fines have already happened.

However, there are two ways to play the banks in the US – either through the mega caps such as UBS’s Tom Digenan and Legg Mason’s Sam Peters, or by targeting regional banks in a bid to benefit from ‘local’ dynamics.

Nick Ford and Hugh Grieves, who run Miton’s £79m US Opportunities fund, have made a major play into mid- and small-cap banks in the US.

Mr Ford said: “We think we are on the cusp of a period of strong performance from mid- and smaller-cap banks, which have generally trailed the market. The fund now has a significant weighting here. [It] already holds Texas Capital Bancshares and SVB Financial and we have added two new regional bank names – City National and Wintrust Financial – and are very bullish on their prospects.

“Higher required capital ratios should leave these domestic-focused banks less vulnerable to unexpected external shocks, and loan loss reserves continue to decline; stricter regulation has helped credit quality. The end of stimulus measures in the US will help profits as well, as spreads on some products rise.”