Rising interest rates might seem favourable for UK banks, but longer-term the business model of high street lenders remains challenged. With interest rates in the UK ticking up, all banks have potential upside – due to the greater amount of interest they can charge on the loans provided to consumers.
It’s understandable, then, that investors may think it’s a good idea to hold one or two banks in their portfolios, particularly when their dividend payments (restarted last year after an enforced break during the worst of the pandemic) are taken into account.
But we believe there are other ways to play the relative strength in financials. Besides Barclays, which we believe is underappreciated given its proven investment banking capacity and more international focus, we own no UK high street banks.
We do not avoid financials as a sector. Instead, we look for companies that have a more diversified asset base and more pricing power than high street banks.
Here are five financials we do own:
Close Brothers
We have held this on and off in the Church House UK Equity Fund since inception. The Fund recently had its 21st birthday, and Close Brothers was held in the portfolio on day one. We like it because it is an old school merchant bank with slightly different DNA. The core banking part is not high street but private financing to small regional businesses: supporting the nuts and bolts of the UK economy.
The company has historically been run very conservatively, which we like as it has proven through multiple cycles that, rather than just grow the loan book, it will do so only when pricing is right and the returns on offer are decent relevant to the risk it is taking on. Finally, it owns broker Winterflood, which has done brilliantly in the volatile markets over the past 18 months.
London Stock Exchange Group (LSEG)
We like businesses involved in the asset management sector. Schroders, for example, we owned for almost two decades, and it was a top 10 position throughout that time. On top of asset managers themselves, there are those who provide ancillary services such as LSEG. We added it to our portfolio last year when it had sold off on Brexit and acquisition worries.
Its barriers to entry are very high, since it has a 99% market share in some of its exchange and clearing house businesses. It is not simply a stock exchange business, and the market seems to forget this periodically.
The recent acquisition of Refinitiv further diversifies LSEG and, so far, the integration is on time and ahead of budget – we believe shares are positioned to re-rate higher as the integration risk reduces over the next few quarters.
Hargreaves Lansdown & IntegraFin
Platform businesses are another service area of the asset management industry that are both capital light and cash negative. Hargreaves Lansdown (HL) is probably the best known in the retail investor space and has benefited handsomely from an increased interest in self-directed investment.
Despite a recent share price slump, HL benefited from record inflows during 2020 and is well-placed to build on this success by encouraging these new users to use the HL platform for their long-term savings and pensions.
Meanwhile, IntegraFin, which owns Transact, is used by more than 6,000 financial advisers directing over £41bn in client funds. It is a ‘pure-play’ platform business offering best in class client service to its UK adviser customers. Customer loyalty is high and revenue excellent.
Barclays
We have held Barclays for a while now on the basis that it is fairly unique among the high street banks due to its capital markets business. This proved to be beneficial last year when it provided a counter-cyclical ballast while the consumer part of the business was threatened.
The price-to-book (PTB) of Barclays versus comparable US banks is another reason we think it is attractive. It currently sits on around 0.54xPTB compared with JPMorgan’s 1.83xPTB. They are not exactly comparable businesses, but this is a large discrepancy in our view.
We added to our Barclays holding in March and June of last year when financials were out of favour and subsequently benefited from the value rally. We trimmed at the end of last year.
Fred Mahon is a portfolio manager at Church House. The views expressed above are his own and should not be taken as investment advice.