Your IndustryJul 29 2013

The Rise of Financials - July 2013

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Approx.60min

    The Rise of Financials - July 2013

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      cisi-logo
      CPD
      Approx.60min
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      Introduction

      By Nyree Stewart
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      Thanks to long years of highly attractive dividend payments, many financials stocks were a core holding for established UK equity funds.

      However, the sub-prime financials crisis of 2007-08 sparked a worldwide meltdown in the sector, with US investment bank Lehman Brothers collapsing in September 2008, and UK banks Royal Bank of Scotland Group and Lloyds Banking Group falling under state control soon after.

      Rob James, UK equities analyst at Old Mutual Global Investors, says: “To understand what happened you have to go back 10 years. It kicked off with the introduction of the International Financial Reporting Standard (IFRS) and Basel 2.”

      The consequence of those two initiatives was that banks increased the size of their balance sheets and bought assets from around the globe.

      “When the sub-prime market popped, all those assets that had been deemed to be safe weren’t, but because they were over the counter, no-one knew who had it,” he adds.

      David Moss, director of European equities at F&C Asset Management, says investors rapidly realised banks’ assets were highly questionable.

      “You couldn’t trust the balance sheets, we knew the banks didn’t have enough equity and at the worst point of the crisis they couldn’t fund themselves either. That led to a massive distrust of banks, and all banks were treated the same.”

      Chris White, head of UK equities at Premier Asset Management, agrees banks “gorged themselves and got overbloated”, hoarding toxic assets.

      “The only way they could work through those assets was to split themselves into a core bank and a bad bank and wind down the bad bank over time from the profits from the core bank. That is what the banks have been going through. Now investors can see light at the end of the tunnel.”

      Stephen Macklow-Smith, European equities senior portfolio manager and strategist at JP Morgan Asset Management, says once the immediate liquidity problems were solved, authorities took steps to prevent it happening again.

      “What is important now, and what is changing, is that capital levels are in the process of being, or have largely been rebuilt. Relative to book values, bank prices look very low and at some point they are going to be a very good value trade.”

      Nick Brind, manager of the Polar Capital Financials Income fund, suggests bank balance sheets are now “measurably stronger than they were before”, but a catalyst for them becoming more attractive is the lure of dividends and buybacks.

      “We saw it two years ago in the US, as they repaid TARP [Troubled Asset Relief Program] and started paying dividends and doing buybacks, then the sector started to rerate quite strongly. You’ve now started to see it a little bit in Europe.”

      It looks as if the painful process of the past few years may finally be paying dividends.