Shares in Lloyds Bank rallied by close to 5 per cent on Wednesday after it announced a 26 per cent increase in profits, with investors flooding in in the hope that it has finally turned the corner more than a decade after the financial crisis.
However, Jamie Ward, manager of the four FE Crown-rated FP CRUX UK fund, said that while Lloyds may have grabbed the headlines this week, his preferred choice in the sector is a bank whose similarly robust set of results received far less attention – Barclays.
Performance of stock (share price and total return) since pre-crisis peak
Source: FE Analytics
Ward aims to find businesses whose value can compound over long periods of time, saying he is always thinking about “where they could be in 2030 or 2040”, and this strategy has led him to the out-of-favour UK banking sector.
“I think a lot of investors, especially the ones that have done very well over the last 10 years by taking quite specific bets, look at what happened in 2008 and say ‘banks are rubbish, I don’t want to be near them and over the past five years they have done poorly in share price returns, so what difference does it make?’” said the manager.
“Looking forwards, I think 20 per cent of the portfolio is in banks. You can make a case for these going back to the kind of businesses they were in the 1960s.
“They have got strong balance sheets, you know I think capital ratios are about as good as they have been for about 50 years, and ultimately because they have the kind of oligopoly driven by regulation more than anything, they will always be able to extract an economic return over the long term.”
Ward said that the three major UK-focused banks – Lloyds, RBS and Barclays – “are all fine” and have the ability to compound value over the next decade or so.
Valuations of UK banks
Source: Hargreaves Lansdown
On Lloyds in particular, he said: “The figures were slightly weak the other day but if you look at the amount they can distribute in capital from now on, it is huge. Even this year it is probably 10 per cent of the business.”
The manager is not particularly worried about the threat from challenger banks, either, saying he is sceptical they will ever be able to replicate the cost of funding (the interest rate paid for the funds they deploy) of the main players.
“You need a huge amount of capital with banks and for every asset [such as a loan] there needs to be a liability [such as a deposit],” he explained.
“And banks are unlike any other business except insurance as their competitive position is not driven by assets – anyone can write a loan basically, as long as you’ve got a banking licence, and that drives down returns. Where the competitive advantage lies is their liabilities, it’s their cost of funding, not their returns.”
However, despite Ward’s optimism for the sector, he only holds Barclays. This is a function of his negative view of risk by which he aims to ensure he is not overly exposed to a single factor that has the potential to cause a permanent loss of capital.
The manager added that with geographical diversity “the only freebie in portfolio management”, holding all three banks would make him overexposed to UK earnings and prevent him from owning other areas of the domestic market.
His preference for Barclays is based on its management team, which he described as “probably the best in Europe and certainly in the UK”.
“They are all basically JP Morgan alumnus and I think that they will be able to extract the unnecessary costs that were in that business so that they can drive returns high across the board,” he continued.
“And it is interesting, you have had this thing with Ed Bramson [chief executive officer of activist investor Sherborne] trying to split up Barclays because he thinks that if you take out BarCap [Barclays Capital, Barclays’ investment banking division], you get returns much higher in the rest of the bank. Which is true in the short term, but if I had to back a management team to actually turn BarCap into a decent business, it would be that management team and I think they can do it.
“And Barclays, I think from 2021 onwards, probably has the capability of distributing the equivalent of 10 to 13 per cent of its current market cap per annum. That’s nuts.
“The banks are much better businesses than people think they are.”
Nine funds in the IA UK Equity Income sector hold Barclays in their top-10, including L&G UK Equity Income and FP Miton Income.
Brokers appear overwhelmingly positive on the stock, with Deutsche Bank, Shore Capital, Jefferies International, Credit Suisse, JP Morgan Cazenove and HSBC awarding it a “buy” rating or equivalent.
Ian Forrest, investment research analyst at The Share Centre, was more cautious. Discussing the bank’s annual results, released yesterday, he said: “Barclays reported better than expected results from its trading activities, making it one of the winners in the banking sector so far in the current reporting.
“It wasn’t all good news for the bank as Brexit inevitably reared its head, leading to a £150m charge in the final quarter of 2018 due to the increased economic uncertainty.
“The more than doubling of the dividend to 6.5p is also welcome, but litigation and conduct charges remain a significant drag on performance at £2.2bn last year. We maintain a medium-risk ‘hold’ recommendation for a balanced portfolio.”
Data from FE Analytics shows FP CRUX UK has made 27.87 per cent since Ward became manager at the start of 2016, compared with gains of 28.58 per cent from the FTSE All Share and 20.93 per cent from the IA UK All Companies sector.
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
The £60m fund has ongoing charges of 0.94 per cent.