Neil Birrell, manager of the Premier Diversified fund
Low or negative interest rates and tepid economic growth have weighed on bank profitability in most developed markets. Some banks are crippled by non-performing loans or are severely under-capitalised like Deutsche Bank. Banks are ultimately a geared play on the economy, so when that splutters they have historically made for poor investments.
The uncertainty of Brexit and low rates means we are not too enthusiastic about UK high street banks. Elsewhere, good-looking bank investments can be found, but it is vital to avoid value traps and focus on companies with financial strength and growth prospects. Central and Eastern Europe are experiencing impressive growth, and banks such as Austrian-based Erste Bank and OTP in Hungary are benefitting from their operations in these regions. Lower government and private debt levels and faster growing economies have made these regions a more favourable operating environment for banks.
US financials remain relatively attractive after being recapitalised during the financial crisis. With US interest rates likely to rise, the financial strength, rising net interest margins and loan growth of US banks should see the sector continuing to perform strongly and many still trade below book value.
Financially strong banks in a favourable environment can generate strong returns for investors. Unfortunately many are under capitalised and struggling in a low interest rate environment. Be very selective and avoid the temptation of the value traps for now.
David Coombs, head of multi-asset investments at Rathbones
It has been a tough environment for the banking sector worldwide. Extremely low interest rates have dragged down the profitability of high street lending, while regulation has made investment banking more difficult. Punishments for past misdeeds continue to fall out of the woodwork – along with more scandals.
However, we have found some top-quality operators amid this sector-wide cloud that we believe offer great value. We own BankUnited, which is focused on disciplined capital allocation in the few markets it operates in (Florida and New York). Its managers are some of the most respected and experienced in the business.
We also own Danske Bank, the leading lender in Denmark. It is led by a respected management team that has delivered attractive returns on equity regardless of difficult circumstances and has one of the highest core tier 1 capital ratios of any bank around the globe. Danske was quick to reduce its branch network, creating the cost savings that have kept margins stable. And there are plans to streamline the business further, which would make it one of the leanest lenders in the world.
Most banks are large and complex institutions. Investing in them can be difficult because of the opacity of all the moving parts. However, we think strong managers leading banks with simple business models make attractive investment cases. These are the lenders we like.
Ben Kumar, investment manager at 7IM
Although the current interest rate environment is not great for banks, there are signs that we may be exiting the zero rate world. If the Federal Reserve can truly get a rate cycle going (rather than just hiking once a year in December like a monetary Santa Claus), then bank earnings should be among the first beneficiaries. If investors start taking a rising rate world seriously, bank shares should see continued gains – indeed, over the past three months, the US Banks index has outperformed the main US market by over 10 per cent, so this may be happening already.
In terms of which banks to focus on, our simple view would be none of them and all of them. The hangover from the financial crisis means that individual banks are susceptible to idiosyncratic legal or regulatory blow-ups, and it is difficult to try and assess which the next one will be. Look at Wells Fargo this year, which held up for so long as one of the best behaved US banks through 2008, but is now battling to save its reputation. Or take Deutsche Bank, once the symbol of Germany probity, now battling to persuade investors it can last from one quarter to the next.
The banking sector should benefit, but picking individual stocks is something of a lottery given who knows where the next scandal will come from. Investing across a broad range of banking stocks, via an ETF for example, is probably the easiest way to avoid coming a cropper.