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Sector Watch: Banks

Daniel Lane

Daniel Lane - Fidelity Personal Investing

They’ve been broadly out of favour since the financial crash but it might be time to re-examine the case for banks. What have they done to tighten their capital controls and is it enough to entice investors back to the sector?

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Why banks?

It is over a decade since the crisis and, while some parts of the banking world are almost unrecognisable by comparison, one aspect remains very similar. Interest rates, dropped to record lows in the aftermath of the worst market turmoil since the 1920s, are still hovering in post-crisis territory.

Years of rock bottom interest rates have put a squeeze on banks’ net interest margins - the difference between what they pay out in return for placing our savings with them, and what they charge to take out a loan.

As a result, the lower-for-longer rate environment has been hard on the sector and is one of the main reasons investors have gone elsewhere but that could be starting to change. Tentative, as they have been, central banks are still focused on picking up the pace of rate rises on both sides of the Atlantic, bringing investors’ attention with them.

Regulators have been far more demanding on capital and liquidity requirements since 2008 as well, leading to low debt and large cash reserves across the sector in a bid to firm up public confidence, as well as the institutions themselves.

There is now very little patience for the risky trading activity and relaxed loan approvals we saw before the crash. This massive reduction in exuberant lending and the shoring up of balance sheets, as well as subsequent consolidation in the space mean banks are in a much stronger position than many would remember.

What’s happening at the moment?

Despite recent short-term blips, both the Federal Reserve and the Bank of England are planning a smooth, measured trajectory upward for rates. As a result, many expect net interest margins to expand, boosting profitability. The return of capital to shareholders through dividends and share buybacks should go some way to ease the reticence among investors, helping the sector to shed its structurally flawed image.

Even in a period of weak economic growth, which might hit their earnings, banks’ capital ratios should be able to pay decent dividends, and with many fund managers eyeing seemingly cheap bank shares compared to the rest of the market, investors could snap up a value opportunity or two.

What to keep in mind

Tighter regulation and cleaner balance sheets may have brought banks back onto many investors’ radars but with greater credibility comes the probability of lower returns than pre-crisis levels. Whereas impressive share price rises were often propped up by leverage, returns should be expected to be more reasonable across the board - a positive result for long-term investors.

That said, the intricacies of major banks’ accounts can still prove difficult to interpret for the everyday investor. While not necessarily opaque themselves, the volume and velocity of financial instruments like derivatives flowing through the system can be daunting. But, to the studious go the spoils - even if that means outsourcing the analysis to a fund manager and their team of analysts.

What’s a good way to invest in banks?

For direct access to the shares of some of the biggest global banks, investors need only look to the FTSE 100. The likes of Barclays, HSBC, Lloyds, RBS and Standard Chartered are represented on the UK market. However, for investors more comfortable with a diversified approach to owning bank shares, the Fidelity Select 50 list of preferred funds features a range of portfolios with exposure to the sector.

The Fidelity Special Situations Fund names Citigroup as one of its top holdings. And, having returned to the private sector in 2017, Lloyds features in the JOHCM UK Equity Income Fund alongside Barclays.

The Majedie UK Equity Fund and the Franklin UK Equity Income Fund both include HSBC in their top 10 names too.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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