What does the future hold for financial stocks?

8th March 2013

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Bumper losses, fines, the libor scandal, and downgrades – financial stocks have endured a torrid time in recent years, while public confidence in the system has taken a battering, but could there be a reversal in fortune on the cards? Harriet Meyer reports.

The storm has far from blown out, with news of bailed-out RBS and Lloyds posting facing fresh losses this week, while Royal Sun Alliance slashed its dividend by more than 30 per cent, and Aviva saw 12.5 per cent share price falls following a huge write down on its US business losses around £3bn and a dividend cut of a quarter..

Yet despite the battering banks and some insurers have endured, and the negative perception, financials have posted impressive gains over the past year, even though they have remained widely shunned by investors.

The MSCI World Financials Index rose more than 19 per cent over the past 12 months, against an improving economic backdrop, compared with a rise of just over 10 per cent for the MSCI World Index.

So it is time to take the plunge, and could share prices have further to rise?

Gavin Haynes, investment director at Whitechurch Securities, believes developments in the sector could see further out performance. He says: “While many investors remain cautious of investing in financial companies following the global financial crisis, the sector cannot be ignored.”

Of course, there is the issue of transparency given the scandal surrounding the sector. However, Haynes stresses that regulatory pressure is seeing financial companies restructure their business models, moving from more complex, high-risk areas to an increasingly conservative culture.

He adds: “Financials remain easily the largest sector across the UK and global stockmarkets – making up around 23 per cent of the FTSE All Share index and over 20 per cent of the MSCI World Index. As a result the majority of UK and global funds will contain some exposure to financials companies.”

However, the majority of experts are keen to stamp a word of warning on the sector.

Juliet Schooling-Latter, of Chelsea Financial Services, says: “We have seen a strong rise over the last 12 months but that is mainly due to the fact that the long-term refinancing operation (LTRO) announced by the European Central Bank – and further subsequent funding – meaning that banks can get such cheap loans so that it will be almost impossible for them to go bust in the next three years or so.

“However, there are still many question marks over the sector, as government debt issues still remain, and most managers seem to still be largely avoiding it.”

Neil Woodford at Invesco Perpetual has steered clear from banks for some time and has not shown signs of wanting to buy back in. This is despite Woodford owning bank shares in the past – in the 1990s had about 30 per cent of the Invesco Perpetual Income fund invested in the sector – with Lloyds as a large holding.

The unstable situation in major economies is another reason to tread carefully. Brian Dennehy, from Dennehy Weller & Co, says:“ The world’s financial system remains at the centre of a unique and huge financial experiment, and this is unlikely to be unwound without significant pain – be wary.”

The UK bank index is still more than 30 per cent lower while the World Financials index is 7 per cent lower than at the start of the financial crisis, stresses Schooling-Latter.

She says: “Arguably you could say that banks are very cheap and there is less downside now, but they are still very difficult to value, and I think it’s going to be a choppy ride and a risky one for anyone wanting to cash in their investment in the next few years.”

However, for investors one way to spread the risk over the long-term one option is a collective investment fund. Adrian Lowcock, senior investment manager at Hargreaves Lansdown, says: “Banks remain a traders stock, as they frequently appear in the top most trade stock lists, and as such they can be highly volatile and sensitive to changes in sentiment.”

So to spread risk and benefit from an expert take, the favourite specialist fund in the sector Jupiter Financial Opportunities. While the fund has not participated in some of the rallies of recent years, it managing to avoid the hefty falls following the takeover of Bear Stearns in 2008 and the collapse of Lehmans.

Guy de Blonay, manager of the fund, continues to see upside potential in the sector, and focuses on structural themes such as the growth in emerging markets financial services and the move to a ‘cashless society’.

He says: “The sector has a wide range of stocks and regions, and investors tend to forget that, including asset managers and credit card providers – so it’s not just about banks.”

Unlike the developed world, the financial sector in many emerging markets is in rude health, and has a strong structural growth story for investors to take advantage of. De Blonay says: “Also, nowhere in the globe is at the same point in the cycle for this sector – the UK is in a different position to the US and India, for instance.”

The fund is split between ‘growth’ and ‘restructuring’ stocks. Visa and Mastercard are in the former group of stocks, to benefit from the growth of online shopping.

The widespread changes in the sector could also be a catalyst for a turnaround. “In the second bracket we have stocks such as Barclays and Citigroup that are starting to reallocate resources to reap the benefits of this,” says de Blonay.

However, with the sector making up over 20 per cent of UK and Global indices, many investors using a broad-based actively managed fund will already hold significant exposure. Lowcock favours Fidelity Special Situations as a fund offering a wide range of sectors so profits can be taken on financials and other areas shifted to at suitable times.

Toby Gibb, investment director for Fidelity’s UK equity team, stresses that stock such as Lloyds and HSBC are in the top five holdings for this fund, with potential for growth. “There is room for improvement as deleveraging occurs and when interest rates eventually start to rise – although banks might not get back to the high returns seen during the debt bubble.”

But remember that if the global economy takes a turn for the worse financials could be further hit – along with other sectors – so caution and spreading your bets is wise.

25 thoughts on “What does the future hold for financial stocks?”

  1. Anonymous says:

    Hi Shaun,

    I regard annuity investments as a waste of time. Once in the depths of our history, mutuals worked for the benefit of members, and their staff took fair remuneration. Now I see the annuity companies creaming excessive profits and their directors taking excessive salaries. The politicians are also stealing from the pot – especially Blair & Brown’s 1997 tax heist. As you rightly point out, the rules change with depressing regularity.

    In short the governance is failing the investors. Hence I won’t invest into a rigged game that I cannot win.

    1. Anonymous says:

      Hi ExpatInBG

      I agree that a big advance here is that now everyone will have the chance of not taking an annuity. Previously the options were only available for very small schemes (who could take a taxed lump sum) or larger ones who had the option of income drawdown. Let us hope that it makes annuities more competitive and better priced as that has to be good for pension saving….

  2. forbin says:

    to my mind the game is rigged again to boost housing prices

    and a lot could go wrong with that

    see therrawbuzzin comments – people will buy houses to rent as thats the better return in this so called “temporary ” emergency must help the Banks out at all costs , times

    I foresee a big headache later on…..

    ExpatlnBG is right about bodger brown and expect some more “beneficial” tax changes in the next few years to decades…..

    Forbin

    Meh sucrose drops but popcorn is still on the up ….

    1. dutch says:

      Agree Forbin,it does seem like a mechanism to boost/maintain house prices and therefore’s RBS’s solvency.

      Which will work till it doesn’t and then the deficit spending will stop and all the tenants will head back to the various bits of the EU they came from with their savings.

      I have numerous friends who’ve taken the BTL route who have assumed that rent and IR’s are constants in the equation.

      1. Anonymous says:

        Agreed. Housing has become the “stock tips from the shoeshine boy”. Everyone is at it. UK in it’s death throes.

    2. Anonymous says:

      Hi Forbin

      The more they rig things the more dangerous it all gets as the bust will be greater. As to corn no real action today as it sits just below US $5.

  3. anteos says:

    Great article Shaun.

    Previously I expected problems with the economy around the next election. But the ponzi Chancellor has played a blinder, another few years to keep the plates spinning.

    There will now be a wall of money sloshing into the economy to boost spending. As forbin has commented, a lot of this will go into housing. Old people don’t trust equities or the stock market, but they know what housing only goes up.

    So government revenue will be boosted by taxation of these pensions, and stamp duty from the property.

    What could possibly go wrong…..

    1. Anonymous says:

      Hi Anteos,

      The early 1990’s were a time of house price falls, negative equity and many repossessions. Ergo I’d disagree with “housing only goes up”. The big plus is ownership, no pension company directors to be paid – the minuses are the need to deal with rental estate agents and the risk of a tenant trashing the property.

      1. therrawbuzzin says:

        Tenants trashing properties is a risk.
        Chancellors trashing annuities is a certainty.

        1. Anonymous says:

          I’ve heard of not trashing but leaving things in disrepair, things missing, soiled etc, even from “respectable” rentals, nowhere near HB.

    2. Anonymous says:

      Hi Anteos and thank you

      We have moved into general election mode in policy in the UK even though it is just over a year away. So the coalition government will try to keep all the economic plates spinning until then. However post-election whoever wins is likely to put the squeeze on a bit and the Bank of England may join in so it could all start to look rather different.

  4. ernie says:

    Hi Shaun
    I haven’t posted for a while but would like to add my comments to this particular subject.
    I think these changes are on the whole definitely a step in the right direction. It’s of course obvious that the reason for the changes is purely political, in order to boost house prices and gain votes, but in any event the move to give people greater freedom over their own assets is the way to go. If people make mistaken choices (which may include BTL at historic high prices/low interest rates?) then at least they made the choices, and were not forced into them by government taxation policy. Annuities were a very poor deal, subject to poor returns, inflation and ultimately confiscation.

    1. Anonymous says:

      I think that’s the best summary. For Osborne the potential boost to spending is a “happy coincidence”.

    2. Anonymous says:

      Hi Ernie

      Welcome back and I completely agree with your case for liberalisation which I hope will start to bring pension saving out of the doldrums it has been in.

  5. Paul C says:

    I was very surprised by Osborne’s move. I felt that annuities and actuarial work was one of those rigged industries, like retail banking and petrol forecourts, or youth car insurance. Every provider moves slowly and in tandem, with the market managed aim of fleecing most of the customers most of the time.

    I think it is refreshing, it puts the pension saver back in the position of bargaining power they should already have commanded, they can now choose to buy an annuity or not buy one.

    Someone or a group must have really pissed off the Government for them to spring this surprise, perhaps it was L&G threatening to build tons of houses with annuity funds? That would have worried the “cosy and constrained supply” house-builders and also improved supply (thereby potentially arresting price rises). Much better that individuals use their risk-averse “later life” agendas to secure an existing asset (property). I note that L&G have since decided to buy existing Housing Association properties instead of building any so don’t worry everything is OK again…

    What is really behind it is another money spending ruse, another jolt of “fake” money into the gambling machine that is the UK. The state knows that they have limit to how much they can print and spend. Just imagine if they could get this whole cohort of baby-boomers to light a series of fires with their cash that would burn for 15 years, and the immediate tax revenue that would come from a grey spending splurge.

    The other very dull choice was to collect the VAT on daily Costa coffees as the aged whittled away at their derisory annuities for way…… too many years.

    Osborne has deftly positioned the boomers to continue his own injections of cash and for many years.

    1. Anonymous says:

      Hi Paul

      Your idea that the pension companies had upset the government by promising to finance house building is an intriguing one. Perhaps they should do it anyway! As a move it is hard to argue against as it does liberalise pension saving and hopefully will encourage more of it.

  6. BoyfromTottenham says:

    It seems that the UK government has “borrowed” this idea from Australia, where the Labor PM Keating introduced its “compulsory super” scheme about 25 years ago. It is a defined contribution scheme, where a percentage (currently 9.5%) of all employees wages are deducted and paid into a super fund, accessible as a lump sum when the employee reaches 55. The assets in Australian super funds now total over A$1.7 trillion, however the key weakness of this scheme (as identified by Shaun) is that once you retire, you have to figure out how to invest your lump sum so as to provide an inflation-proof income stream. Unfortunately there are few real options here in Oz – all the super funds I have looked at offer exactly the same investment options to both accummulating and retired members, and they consist of either growth strategies that are heavily sharemarket exposed, or “safe” but low return options such as cash or bonds. This is made worse in Oz because we have a very small corporate bond market, and funds that do invest in assets with annuity-like returns rarely offer them to members, preferring to lump them into their “ready-mixed” options instead. Overall, the “compulsory super” scheme here in Oz has allowed many employees to accumulate significant lump sums, but at the same time has lumbered them with all the risks as well!

    1. Anonymous says:

      Hi BoyfromTottenham

      The UK is also in the process of copying the “compulsory super” scheme via what is called NEST which is currently building up its levels.

      As to drawing from such a scheme there are some advantages in Oz in that Oz Govt bond yields are higher (10 yr 4.1%) and index-linked bonds seem to offer a better return than here too. But the trend to putting all the risks of the individual is a world wide one it would seem.

  7. David Lilley says:

    Shaun,

    I agree that it was an earth moving announcement but it was introduced in the 2010 Conservative manifesto so it should not have been a shock.

    The BBC ran a post introducing ten possible unforeseen outcomes and Neil Lovett of the Friendly Society made the case that this was a hidden tax cut for the baby boomers in a guest post on Mindfullmoney.com. I made the antithesis case but one of our regular commenters, Noo 2 economics, ran me out of the room with his superior knowledge.

    1. Anonymous says:

      Hi David

      Surely the implementation of a manifesto pledge is something of a shock these days!

  8. Anonymous says:

    Long time Shaun, though still enjoying your valuable takes.

    Mr Osborne has pulled off a master stroke. A later day Robin Hood. In one foul swoop he has ensured the nova senior citizen’s vote and mullered those who offered derisory returns for your hard-earned cash while quaffing Chateau ………
    I was one of the lucky ones who have managed to un-retire and postpone my date until April 2015 or thereafter and, I also have the ability to hand over the spoils to my nearest and dearest should I cease to exist. I love my old banger and have a few shillings of mortgage outstanding. I’m sure they’ll be offering us iPads to accompany our morning juice.
    I do feel for those who weren’t / aren’t so lucky.
    There is an element of making your own luck, as you all well know.

    1. Anonymous says:

      Hi KnaveOfHerts

      Welcome back and without revealing you personal details too much it would be interesting to get a handle on how much you think that this changed has and will benefit you?

      1. Anonymous says:

        Enhanced annuity: yield = 5% of the pot, fixed, or 20 years under the mattress.
        Let’s try a buy to let: yield = 5% and whatever you’ve bought you still have. Clock ticks and things usually inflate.
        Stocks and shares…..
        Bonds
        So in reality, if you manage your pot with minimal effort, it isn’t too hard to get a similar return and possibly have a pot to …. in and hand down or head off into the sunset.
        Plain and simply it has given us control of our finances. Not forgetting that HMRC is still getting a slice of the action whichever route you take.
        Benefit? How does 30+ years sound?

  9. dutch says:

    Annuities are a terrible investment by any standards but taking a floating 5%-7% gross yield on a floating asset with substantial costs of carry-such as a house-hardly seems a much better alternative.

    The gross yield on some larger houses in the Midlands is 2%-3%.

    So in order to chase the better yielding stuff you have to take a more substantial counter party risk ie take HB/students.

  10. Anonymous says:

    Hi therawbuzzin

    Yes as I wrote in the article annuities are poor value right now for the customer.

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