Rising interest rates and the tapering of ultra-loose monetary policy mean bank stocks are likely to generate positive gains over the medium term, according to Standard Life Aberdeen’s Roger Sadewsky.
The senior portfolio manager, who works on the £23bn Standard Life Investments Global Absolute Return Strategies (GARS) fund, said the team therefore holds a long position in the sector and has pitted this against a short on expensive consumer staples.
This is despite the fact many investors have flocked to quality-growth stocks year-to-date, with the FTSE World Growth index more than doubling the performance of its value counterpart with a 14.94 per cent return in 2017, so far.
Performance of indices in 2017
Source: FE Analytics
“One strategy we have a lot of faith in is the re-evaluation of the banking sector,” Sadewsky said. “We are clearly seeing a much healthier market in the US where the banks are generating pretty stable positive returns and higher short-term interest rates.
“We have seen several interest rate hikes which means the banks are earning pretty good net interest margins and good money on their excess reserves.”
The reason the management team is expressing its positive view on banks as a relative value strategy versus the consumer staples sector, according to Sadewsky, is that banks have been relatively undervalued by the broader market but consumer staples have been pushed to dangerously high valuations.
“The sector has been one of the biggest beneficiaries of the passive flows into the market,” he explained. “It is a defensive sector where valuations have got to extreme levels.
“What has been quite comforting is that we have had quite a few periods where consumer staples have delivered negative returns while banks have delivered positive ones which illustrates the potential of that strategy.”
Another strategy within GARS that aims to benefit from the strengthening of the banking sector is its relative value trade on European banks versus European equities. It is playing this through a 5 per cent long position in banks versus a short on the Euro STOXX index.
However, Sadewsky admitted this is yet to come through as interest rates in the region have remained supressed.
Performance of indices in 2017
Source: FE Analytics
“European interest rates have been hovering around this 40-basis point level over 10 years,” he said. “European banks have rebuilt their capital and their tier one ratios, credit multipliers are growing and consumer confidence PMIs throughout Europe are rising, not just in the periphery, but the core as well.
“We have valuations in banks at levels not consistent with the European and global upswing.”
The senior portfolio manager believes there is “terrific value” to be had within the European banking sector, despite the fact its current strategy has been one of the fund’s recent drivers of negative returns.
However, even if interest rates remain low over the medium term, he believes investors will begin to recognise the attractive valuations of European banks at some point.
“There have been some concerns and natural questions regarding Catalonia but we think it is a very minor part of the European banking sector as a whole,” Sadwesky reasoned. “We have to see how in Spain banks will treat that political stress. But it’s a relatively small part and we do think there are very nice gains to be made in European banks.”
Of course, the team’s bullishness on banks is dependent on interest rate movements. The senior portfolio manager pointed out that, as central banks across the globe become more hawkish, the Bank of England will feel increasing pressure to hike rates next month.
He said this expectation led to a temporary rally in the 10-year gilt market, although yields have since returned to where they were at the start of the financial quarter.
“That has had an impact on the overall portfolio. If we look at some of the negative returns, some of those have come from the UK where we have lost money on long gilts versus a short Germany strategy,” Sadewsky said.
“This would benefit from a taper. We believe that German rates are low relative to history and the rest of the world, but so far the market has been more relaxed. They are unsustainably low. This was the biggest negative in the quarter.”
Over the last quarter, Standard Life GARS has lost 24 basis points compared to its Libor GBP 6 Months benchmark’s return of 11 basis points.
That said, investors should bear in mind that the fund’s aim is to achieve a positive return during all market conditions over rolling three-year periods.
Over the last three years, the fund has outperformed its benchmark by 89 basis points with a total return of 2.78 per cent.
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
It has done so with an annualised volatility of 4.28 per cent and a maximum drawdown – which measures the most money lost if bought and sold at the worst possible times – of 6.31 per cent.
Standard Life GARS has a clean ongoing charges figure (OCF) of 0.88 per cent and yields 1.22 per cent.