As the UK recovery gains momentum and memories of government bailouts recede, many fund manager and investors have begun considering banks to generate income, but Harrison thinks they offer little exposure to the recovery.
The safer end of the market such as HSBC offers little prospect of growth, he says, while credit-crunch causalities such as RBS, Lloyds and Barclays are too risky despite recent improvements.
“With the bigger and safer banks such as HSBC and Standard Chartered, we feel their growth outlook to be unattractive compared with elsewhere in the equities market,” he said.
“At the recovery end of the market, the likes of Barclays, Royal Bank of Scotland and Lloyds, there are too many uncertainties around the banks’ health, relative to their value.”
“We’ve got big positions in other financial institutions. It’s really retail banks specifically that we don’t like.”
Harrison is Threadneedle’s head of equities and co-manages three funds with Richard Colwell.
Threadneedle UK Equity Income and the £700m Threadneedle UK Equity Alpha Income fund are both top-quartile performers in their sector over the last one and three years.
The managers say their success comes from contrarian calls: buying stocks when they are out of favour.
Performance of funds vs sector and index over 3yrs
Source: FE Analytics
According to FE Analytics, both funds have outperformed their sector and benchmark over three years.
Threadneedle UK Equity Alpha Income returned 62.55 per cent to investors while Threadneedle UK Equity Income returned 54.17 per cent, compared with a sector average of 41.96 per cent and 32.19 per cent from the FTSE All Share.
“With the safer banks such as HSBC and Standard Chartered, you get a good yield, modest growth and limited capital growth upside. There’s nothing wrong with them but not enough right with it,” Harrison said.
According to FE Analytics, HSBC has made 6.89 per cent over three years while Standard Chartered has lost 15.23 per cent, both hit by emerging market weakness.
Over that period they tracked the FTSE quite closely until June last year when talk of an end to QE in the US hit emerging markets.
Performance of stocks vs index over 3yrs
Source: FE Analytics
“We feel with Standard Chartered you get some exposure to Asian growth but there’s also some financial risk because within their balance sheet there’s some suggestion they’re short of capital,” Harrison explained.
“You might find what you’re buying is not what you thought it is if there’s some fund-raising around the corner.”
Royal Bank of Scotland, Lloyds and Barclays were the UK high street banks hit hardest by the financial crisis and all required government bailouts.
Some investors have bought them in anticipation of a return to dividend payouts, but Harrison says this is not wise.
“With RBS and Lloyds you’ve got no income coming through, and we still think there are some big issues in RBS that need sorting out.”
“There’s an expectation that you’ll get a decent yield from both of them in due course but we’d rather wait until there’s clearer visibility about that.”
“There are too many uncertainties about Barclays, although the valuation looks OK. We are concerned about it mainly because of its investment banking heritage.”
“We’re in the middle of a massive structural change in the investment banking industry and with RBS closing down its investment banking business, it’s still very much a life-threatening situation for some people.”
Performance of stocks vs index over 3 yrs
Source: FE Analytics
Of the three, Lloyds has been the strongest performer over the past two years, according to FE Analytics. It has returned 135.8 per cent, recovering from a low base after it incurred huge losses in 2011.
It has become a very popular stock among UK fund managers since the start of the recovery, with many continuing to hold it.
However, Lloyds' latest results, delivered in February, failed to impress the markets, raising the question of whether the bank’s spectacular recovery has already played out and investors should sell the stock.
It was one of the best performers in the market in 2012, returning 85.02 per cent to investors and gaining a further 64.61 per cent last year.
“Lloyds is looking much safer but it’s already looking reasonably valued, so in the round they all sort of stack up a bit, but when I compare them with AstraZeneca I just think 'I’m not going to take the plunge'.”
Another FE Alpha Manager, Leigh Himsworth, who heads up the City Financial UK Select Opportunities fund, disagrees with Harrison and has recently upped his stake in Lloyds.
“We’re into a modest recovery so that should be good news for increased lending,” he said.
“Also, with people expecting a recovery, it will be good news for banks because with rising bond yields, they will be able to lend at low rates and get people to pay them back at higher rates, as margins rise.”
“I prefer Lloyds because with the safer banks like HSBC, you don’t see the same gearing in your portfolio, you want a bit more sex and violence.”