Until only recently, UK banks were one of the most loathed asset classes among investors thanks to their dreadful run during the global financial crisis. Very strong share price performance in 2012 has turned some heads, but they remain a big underweight across most UK equity funds.
However Kirrage, (pictured), who has headed up the £1.3bn Schroder Income fund with Murphy since May 2010, says UK banks are one of his favourite areas of the market at present for a number of reasons. Although the likes of Lloyds have had a good run over the last year or so, Kirrage believes they remain undervalued.
"Banking is the classic example of a sector that was formerly a boring, stable income play that became a basket case out of nowhere," he said.
"Now it’s on its way to not being a basket case anymore and people are starting to remember there’s a lot to like about them."
"They have huge barriers to entry and pricing power and yet you’re paying tangible asset value for them – maybe a little less. It’s a pretty ideal mix."
Performance of stocks vs index over 1yr
Source: FE Analytics
Kirrage and Murphy are value investors, meaning that they prioritise the cheapness of a stock above everything else. The pair head up the Schroder Recovery fund as well as Schroder Income, using their value approach across both portfolios.
Kirrage adds that banks are likely to pay dividends again soon, which will further support their share price from here on in.
"If the sector goes back to being a stable dividend-payer, that’s a whole other dimension that the current share prices are not taking into account," he explained.
"Back in 2005 and 2006, 25 per cent of the dividends in the UK market came from banks. That’s now close to zero, but it won’t be for long."
"Banks are natural dividend-payers, and I think they’ll be paying a decent yield again soon. No, I don’t think they’ll have massive headline yields, but on a five- to 10-year view, they’ll be an attractive prospect for investors who want dividend growth."
"Equity income funds are increasingly looking for dividend growth, and these are a good bet. This, combined with the fact they are very cheap, is a great combination."
The manager likens the banks to life insurance companies a year or two ago, when they started paying dividends again.
"In 2008 and 2009, life insurance companies like L&G died a death, cutting their dividends across the board. Over the last three or four years they have been building their capital reserves and now have a safety net. A lot of them have started paying dividends again, so are a little ahead, but it bodes well [for banks]."
Barclays, RBS and Lloyds are top-10 holdings across both the Schroder Income and Schroder Recovery funds, according to FE data. They all have between a 3 and 4 per cent weighting in the funds.
"At the margins, perhaps RBS or Barclays are more attractive given that Lloyds has had such a good run, but I’m a big fan of all three," added Kirrage, who confirmed that he holds Lloyds in his personal ISA portfolio.
Murphy (pictured) says the recent fall in markets has not prompted them to increase or decrease their exposure to banks, because the correction has not had a big enough impact.
"Our views on the banks haven't changed in the past couple of weeks, indeed the past couple of years," he said. "When investing, we take a much longer time horizon than most, and try to think about the stocks on a three- to five-year view, rather than some people in the market who appear to think about the next three to five minutes."
"This means that our view on stocks changes very slowly, and 5 to 10 per cent price differentials are not that relevant to us. For the recovery fund, we'll be buying things when they have around 100 per cent upside, and so 10 per cent moves are pretty insignificant in the context of where we think share prices can go."
Performance of stocks and indices over 3months
Source: FE Analytics
Although Barclays and RBS have followed the FTSE All Share down by around 10 per cent since the end of May, Lloyds’ share price has hardly been affected.
The Schroder Income fund has had a mixed time of it since Kirrage and Murphy took over in May 2010. Their value style, and especially their high exposure to banks, saw the fund significantly underperform in late 2010 and all of 2011.
Performance of fund vs sector and index since May 2010
Source: FE Analytics
However, the fund has recovered since then and is now ahead of its sector and benchmark since they took over. It is currently yielding 3.56 per cent.
Their record as managers of the Schroder Recovery fund is more clear-cut. According to FE data, the £355m portfolio has made 84.96 per cent since July 2006, more than doubling the returns of its sector and benchmark. This puts it in the top decile of the IMA UK All Companies sector.
Schroder Income has an ongoing charges figure (OCF) of 1.66 per cent, while Schorder Recovery charges 1.52 per cent. Both require a minimum investment of £1,000.
Murphy and Kirrage are not the only big fans of Lloyds: in a recent interview with FE Trustnet, chief investment officer at Phoenix Asset Management Gary Channon said the company is an ideal play for a long-term ISA or Junior ISA.
"Banking is essential for every modern capitalist economy," he said. "Banking in the UK is locked-in and the barriers to entry are very high."
"After all the regulations and those forecast for the future, the Government has not been able to take away the most important thing banks have: pricing power."
"Everyone in our office has 100 per cent of their children’s ISA allowance in Lloyds," he added.
Fifty-eight funds in the IMA universe currently hold Lloyds in their top-10, including Fidelity Special Situations and Jupiter Undervalued Assets, which both have more than 7.5 per cent in the company.
Barclays is more popular, appearing in the top-10 of more than 100 IMA funds in total. Julie Dean is a big fan of the company, holding more than 5 per cent of her Cazenove UK Opportunities fund in it.
RBS is the least popular of the three. Jupiter UK Special Sits is one of 22 funds that hold it in their top-10.