The banking sector is becoming one of the best areas of the market to protect against looming headwinds and ‘known unknowns’, according to Schroders’ Nick Kirrage (pictured). 
The FE Alpha Manager, who runs the Schroder Recovery and Global Recovery funds alongside fellow FE Alpha Manager Kevin Murphy, says the sector should be seen as more than just a play on rising inflation.
In fact, he believes that banks have become more and more appealing over the course of several years, despite concerns from many investors surrounding their opacity and susceptibility to fines.
“Over the last 10 years, things have changed, but they’ve changed in a way that people haven’t noticed. It’s that slow-boiling of the lobster,” Kirrage said.
“When you think about banking from the 10,000-feet view, I think the risks have changed too. I can’t think of another sector globally that has been de-risking every year for the last nine years.
“I can think of lots of sectors that did it for three years then went back to the world now where we’re issuing more debt than we did before. Banks are the only ones that get a stress test every year; they get told to provide more capital, reduce loans, more capital, more capital, more capital.
“So the irony is that, despite them being cyclical sectors, they may be one of the best-prepared places in the world to defend against whatever might come.”
Last year’s well-documented rotation from quality growth into value stocks has been a notable tailwind for banks, given the move was based on expectations for inflation rises and potential rate hikes.
However, the sector struggled for several years up until the second half of 2016, following the Lehman Brothers crisis and the subsequent blow this dealt to investor sentiment.
This was further fuelled by a string of scandals – such as the mis-selling of PPI in 2011 – which led to hefty fines and criticism that banks are opaque, untrustworthy businesses.
Performance of indices since 2006 to June 2016
Source: FE Analytics
Kirrage, who has a 31 per cent financials weighting in Schroder Recovery, believes these issues and the subsequent tightening of regulation on the sector has forced banks to become better-equipped to deal with any economic headwinds.
“It’s not about the fact that Canada has a lot more snow than the UK, the truth is their train stations still work when it snows whereas the first time we see a snowflake everything shuts down,” he continued.
“It’s not about whether the weather is bad, it’s about how well-prepared you are for it. I think people are missing that a bit when they’re looking at some of these companies.”
Kirrage isn’t the only manager to have sought solace in banks before the growth/value rotation. In an article published back in 2015, Investec’s Alastair Mundy described Royal Bank of Scotland – arguably one of the more contrarian UK bank stocks – as his “comfort blanket” in an environment he then described as “value hell”.
Performance of stock since 2008
Source: FE Analytics
“It’s a very strange comfort blanket that no one would usually go anywhere near. Other people seem to have common comfort blankets, but the problem is when they disappoint, they’re all going to want to be throwing out that comfort blanket together and I’m not going to be buying that comfort blanket off them,” he said.
While banks are indeed popular now, Kirrage says buying into market areas in a bid to forecast macro events is pointless. He argues that last year’s events demonstrate this perfectly, given that many major indices reacted positively to shock events that many believed would derail markets.
“I think if we had taken clients to one side ahead of time and said,’ I’ll tell you right now, Trump gets in, Brexit happens, and I’ll let you move your portfolio a week ahead of it, what are you going to do?’ People would have gone 70 per cent cash and you’d have got creamed. This is the problem,” he continued.
“It’s not about getting the macro call right, it’s about knowing what the market is going to do and that is why it is such a difficult way to consistently make money.”
The manager says that the ‘value versus growth’ debate has reared its head for the first time in years due to an improved economic outlook. Before the second half of last year, he says investors were uninterested given that value had consistently underperformed growth for several years.
“There are lots of different styles of investing, particularly in the UK where we talk about small-cap, mid-cap and lots of other themes, but we haven’t really been hearing about value investing on the other side: value versus growth,” he reasoned.
“Now we’re in a market where, because nobody has wanted value because it has been so poor, everyone has moved towards a growth-oriented strategy. You saw that last year when we had six very strong months for value and 85 per cent of fund managers underperformed.
“This is an amazing trend because I think what people are doing is looking at a fund manager and saying, ‘okay, I’ve bought two or three funds. I have diversification of fund manager, diversification of fund house, diversification of stocks.
“The managers have all gone and bought different individual stocks, but you have no diversification of style. They have all bought the same types of stocks.”
Since Kirrage and Murphy have been at the helm of Schroder Recovery, it has outperformed its sector average and benchmark by a respective 76.41 and 73.65 basis points with a total return of 173.94 per cent.
Performance of fund vs sector and index under Kirrage and Murphy
Source: FE Analytics
It has a clean ongoing charges figure of 0.91 per cent and yields 1.81 per cent.