Much beloved of many growth funds and increasing more income funds, UK banks face a huge risk from their tiny rivals, according to FE Alpha Manager Mark Barnett, head of UK equities at Invesco Perpetual.
The manager (pictured) of the £6.4bn Invesco Perpetual Income and £12.4bn Invesco Perpetual High Income funds as well as the Keystone and Edinburgh ITs is bullish on financials as a whole but has nothing in the major banks.
“The financial landscape is shifting in favour of tailored customer solutions. Mobile banking, on-line lending, more sophisticated credit scoring and more flexible savings products are all evidence of this trend,” he said.
“Whilst the major banks have not stood still, they have been preoccupied with the legacy of the 2008 global financial crisis and the way has been opened for lower cost more innovative operators to take advantage of newly emerging technologies.”
Approximately a quarter of each of Barnett’s UK portfolios are currently invested in the financials sector although he has had no exposure to conventional banks such as HSBC, Barclays, Lloyds and RBS since 2007.
“The collapse of Lehman Brothers in 2008 and the radical changes to the world’s financial landscape that ensued have given rise to an era of much tighter regulation in order to prevent such a crisis happening again. At the same time, many of the major banks have been hamstrung with varying degrees of bad debt and excessive leverage,” he said.
“This has hampered UK banks’ ability to pay out dividends and also their willingness to lend. This in turn has encouraged borrowers to explore other means of borrowing and new lenders to emerge with lower cost, more entrepreneurial business models.”
“The so-called ‘challenger’ banks such as Virgin Money and Metrobank have made their mark, but remain a relatively small portion of the banking sector and face the same stringent regulatory environment as the older and larger incumbents.”
According to FE Analytics, UK banks as measure by the FTSE 350 Banks index have been underperforming the UK market for about six years, with particular weakness in the past three years.
Performance of indices over 3yrs
Source: FE Analytics
The merits of UK banks as investments divide UK fund managers seemingly like no other sector of the equity market. While many dislike them immensely, the likes of Schroders’ Nick Kirrage and Kevin Murphy and Investec’s Alastair Mundy say they are the cheapest stocks in the market, offering great long-term value following the disastrous falls since the 2007/8 financial crisis.
Mundy (pictured), who has a large weighting to UK banks in his Investec UK Special Situations fund and Temple Bar IT explains by example of the housebuilder Bellway, whose share price plummeted in the financial crisis, why he is backing the banks.
“You might say, ‘okay, even if I sign up to your crazy outlook and that’s pretty bearish, what on earth are you doing holding banks?’” Mundy said.
“The reason I hold banks can be explained through Bellway in June 2008, when Robert Peston was telling everyone it was the end of the world and that we were all going to hell in a handbasket.”
“That was exactly the point we should have been buying housebuilders, not because from that point on housebuilders’ operating conditions drastically improved, but because housebuilders had taken so much punishment by then they just couldn’t take any more in share price terms.”
However, Barnett thinks rise of challenger banks such as MetroBank - which is expected to list on the UK market at some point in early 2016 - and Virgin Money as well as regulatory hurdles make the likes of HSBC, Lloyds, Barclays weak proposition.
Barnett said: “The competitive environment is further intensified by the fact that a number of UK asset managers have recently expanded into loan provision, most notably Legal & General, a company traditionally focused on UK life insurance.
“It [has in] recent years been broadening its product offering by focusing on upscaling other areas of its business such as asset management, capitalising on its long established brand and global reach.”
However, he thinks these stocks slow progress over the past few years is also at risk from further weakness due to the rise of the latest new entries to the market: crowdfunding firms.
Performance of stocks and index over 5yrs
Source: FE Analytics
“Perhaps the most innovative development has come from the growth of peer-to-peer (P2P) lending platforms, where entities are not subject to banking regulation, yet are in a position to offer similar products to that of banks, with lower overheads.
“P2P lenders argue that their credit scoring technology is as good as the banks’, if not more granular, while their turnaround of business is much faster. Because they do not need to hold regulatory capital or liquid assets, operate physical branches or deal with outdated legacy IT systems, their costs of making and administering small short-term loans are much lower than for banks.”
Performance of manager versus peer group composite over 10yrs
Source: FE Analytics
Our data shows Barnett has outperformed his peer group by more than double over the past 10 years with an average return of 170.03 per cent.