Barnett (pictured), manager of four open- and closed-ended portfolios including the five crown-rated Invesco Perpetual UK Strategic Income fund, says he wouldn’t be surprised if the high street banks pay a special dividend at some point next year, but thinks many of his rivals overestimate their capacity to become regular payers. When asked if he was thinking about adding banks across his fund range, he said: “Not yet, no. I personally don’t believe they will be paying dividends in any significant way anytime soon. You might get a token one, but not something sustainable.”
“There are a number of things that I’m still very wary of when it comes to the banks. The capital positions of course, but then you’ve also got the regulatory back-drop which is tight and getting tighter.”
“What is more, these regulations aren’t getting banks into a position where they can leverage again. The Government still wants higher levels of capital on the balance sheets.”
“The domestic banks – so not Standard Chartered or HSBC – are going through a continual period of rehabilitation and there’s no sign of that stopping. I don’t believe they’ll be in a position to generate a growing dividend,” he added.
Research from The Share Centre published today shows that return on capital [ROC] in the UK banking sector has been hard hit by the requirements placed on them to hold extra capital by the regulators, supporting Barnett’s argument.
The Profit Watch publication shows that ROC in the financials sector fell to 3.4 per cent in the year to the end of June from 12.9 per cent in the same period in 2008, helping push the figure on the overall market down to a six-year low.
The manager’s comments suggest he will not be buying up shares in the banks for his Invesco Perpetual Income and High Income funds when he takes over from fellow FE Alpha Manager Neil Woodford in April of next year.
For the time being, the manager prefers to get his exposure to more stable, predictable companies in areas such as healthcare, telecoms and tobacco, as he explained in a recent FE Trustnet article.
The UK banking sector has become increasingly popular with UK Equity Income managers in recent months, who see it as one of the few areas that offers significant upside potential in capital growth terms.
Lloyds, Barclays and RBS have not paid a dividend since the depths of the financial crisis, but many fund managers are confident that it will not be long until they begin to do so.
FE data shows that of the 98 funds in the IMA UK Equity Income sector, 11 hold Barclays in their top-10, five hold Lloyds and five hold RBS.
A further eight investment trusts include Barclays as a major holding. Three hold RBS, while five hold Lloyds.
Among the biggest supporters of the banks at the moment are Nick Kirrage and Kevin Murphy, who hold Barclays, Lloyds and RBS in the top-10 of their £1.4bn Schroder Income fund. The three companies have a weighting of more than 10 per cent.
Kirrage told FE Trustnet in an interview earlier this year that the UK banks will soon be in a position to pay dividends, which will give further support to their share prices when income-hungry investors begin to part with their cash.
António Horta-Osório, chief executive of Lloyds, said earlier this year that he aims to start paying out up to 70 per cent of the bank's earnings in dividends within three years.
Barnett’s aversion to the banks has hurt his relative performance in recent years, with all three major high street banks outperforming the wider FTSE All Share index. Lloyds has been the best performer of the three by far, returning more than 188 per cent over the period, according to FE data.
Performance of stocks and index over 2yrs
Source: FE Analytics
By contrast, Barclays and RBS have returned 60.46 and 48.32 per cent, which still puts them ahead of the All Share.
Lloyds, Barclays and RBS, which are all UK facing, have also beaten the likes of HSBC and Standard Chartered over the period. These two businesses are far more international, with heavy exposure to emerging markets, for example.
In spite of the recent surge in the UK retail banking sector, all are well off their highs prior to the financial crisis, with many industry commentators claiming they have the potential for further recovery.
Performance of stocks and index over 6yrs
Source: FE Analytics
Ian Rees, head of multi-asset research at Premier and co-head of the five-crown rated Premier Multi Asset Distribution fund, says he has no problem with equity income managers who have significant exposure to banks – as long as they sit in a diversified portfolio.
“Am I comfortable with a manager holding the banks? You’ve got to be aware of the risks that they won’t pay a dividend, and given how difficult the regulatory backdrop is, returns to shareholders are certainly vulnerable,” he said.
“However, in the context of a well-diversified portfolio, I think you can justify them being in there. They are generating a huge amount of cash at the moment and there is definitely a case that they will have the ability to pay out a dividend. Whether that translates into them actually paying one is a matter of debate.”
Rees says he holds the Schroder Income portfolio across Premier’s funds of funds range.
“As well as the banks, they have major exposure to the pharmas and they’ve still got a position in things like Vodafone, so they’ve got some very different companies in there,” he added.
Barnett is one of the most established managers in the UK Equity Income sector, leading his fund to consistent outperformance with below-average volatility since he took over Invesco Perpetual UK Strategic Income in 2006.
His reputation in the investment trust sector is also very strong, with Keystone IT, Perpetual Income & Growth IT and Invesco Perpetual Select UK Equity IT all beating their benchmark over the medium- and long-term.
Our data shows that the manager has returned 235.1 per cent over the last decade, beating his peer group composite by more than 80 percentage points, with less volatility.
Performance of managers and peers over 10yrs
Source: FE Analytics
His UK Strategic Income fund requires a minimum investment of £1,000 and has ongoing charges of 1.7 per cent.
To read Barnett’s outlook for equities in 2014, click here.
