Personal finance: Scandals set to scare off many from investing in banks

By Jeff Salway
Published on 09/07/2012 00:00

JURY is out on whether to buy into institutions as yet again big names are shamed, writes Jeff Salway

It’s either a good time to dive in while it
offers value, or a time to steer well clear. The jury is out on whether private investors should hold money in the banking sector after its biggest names once again made headlines for all the wrong reasons.

The furore over interest rate manipulation, which saw Barclays landed with total fines of £290 million and cost its chairman and chief executive their jobs, was merely the latest shameful episode.

Many experts continue to argue against buying into banks, whether directly through shares or through collective funds, pointing to an uncertain economic and regulatory
outlook. Yet there’s another school of thought that considers banks a bargain at current prices for investors happy to hang on for the long-term.

The last few weeks have been dire even by post-banking crisis standards. The Libor scandal claimed victims at Barclays, but they seem certain to be the first of several as scrutiny turns to other banks.

Last month millions of Royal Bank of Scotland and NatWest customers were seriously inconvenienced by an IT meltdown that raised new doubts over the running of the bank’s
operations.

The same week, the City watchdog unveiled evidence that banks including Lloyds, RBS and Barclays had mis-sold interest-rate swaps to thousands of small businesses, leaving many out of pocket.

Barclays and RBS are also among several banks to have their credit worthiness downgraded by ratings agencies.

Share prices have suffered accordingly, with billions of pounds wiped out as the Barclays story unfolded. Prices have since staged a 
partial recovery, but we can be certain that more volatility is on the way.

So where does that leave investors? If you hold money in the banking sector, whether through direct shares or your investment and pension funds, should you be concerned?

Or is this a real chance to buy into banks when they are cheap, on the basis that they are currently priced below their true value?

As William Hunter, director of Edinburgh-based Hunter Wealth Management, pointed out, uncertainty can also present opportunities. The uncertainty would deter him from
investing in banks right now, he said, while noting that investors who stay in for the long-haul could reap the rewards.

“There will be immense perceived value for the braver longer-term investor and potential losses for the short-term foolhardy investor, because of low or no dividends and high
volatility.”

This is not a time for investors to plough new cash into banks, he believes

Haig Bathgate, chief investment officer at Turcan Connell, is more unequivocal, believing that this is no time for investors to plough new cash into banks: “I’d personally recommend that generally people avoid investing new money for the time being – the good quality names such as HSBC are fully priced and there is still too much uncertainty surrounding the partially state owned entities and eurozone banks,” he said.

While there is clearly value to be had out there, due to the current cheap share prices, the regulatory and political risks to the sector are substantial.

The eurozone is an obvious case in point, with concerns over the Spanish banking system and banks across the continent holding assets that will likely be written down.

“Domestically focused UK banks, as we know, also have some significant exposure to Europe and I’d argue that there are likely to be further writedowns in the pipeline,“ said Bathgate.

“The question is whether that is already in the price, but there is simply no way of determining the extent of potential future impairments and that makes any potential investment speculative.”

The argument against too much exposure to banks also takes in the problem of understanding exactly what is and isn’t sitting on balance sheets.

David Thomson, chief investment officer at VWM Wealth Management in Glasgow, said: “A perennial problem of banks in both good times and bad is that they are so opaque and you never really know what you are buying.”

Investing in banks these days is like “trying to catch a falling knife”, he added. For example, with more banks likely to be found guilty of rigging Libor, the Barclays sell-off could prove to have been excessive.

Many brokers continue to recommend buying into Barclays, arguing that the damage is now reflected in the price.

Thomson provided a note of caution, though. “Something else can still come out of left-field, so it’s not a trade for the feint hearted,” he warned.

But what about the long-term outlook? While the short and medium-term picture may be clouded by political and regulatory influences, surely there will come a time when investors will do well to have some exposure to banks? Yet that could be several years away, Thomson believes.

“Our view is that the effects of the credit crunch are going to take years to sort out and investors should perhaps pencil in 2016 to have another look at financials and the property sector,” he said.

While direct share ownership supplies the thrills for traders happy to take the risk, most investors are exposed to bank shares through collective funds such as unit trusts and investment trusts.

One option is a financials fund, which will invest in banks alongside insurers, fund management firms and specialist trading companies, among others.

Thomson leans towards those with the least exposure to the big banking brands.

“If pressed we would invest in a diversified financials fund such as Jupiter Financial Opportunities.

“The fund enjoys a good track record and performed very well in the market recovery in 2009,” he said. “But given the very difficult backdrop it has perhaps unsurprisingly been rather lacklustre in recent years.”

Not only would Hunter avoid banking shares in the current climate, he also cautions against investing in financials funds.

“I don’t believe any sector with a really strong regulatory presence and probably more toxic and potentially criminal issues will advance better than the general economy.”

Instead, he would opt for a broader fund with some bank holdings alongside investments in other sector. Hunter picked out the Fidelity Special situations, which has 26 per cent of its assets in financials, with HSBC as its largest holding.

Bathgate at Turcan Connell is steering clear of banks altogether.

“With the widespread apathy from the public towards the banking sector, this means that the risk of investing in this sector is high with no real visibility of where the return may come from. With the continued failure of the western banking sector more generally to clean up its act, I’d be avoiding for the time being.”