Skagen sees opportunities in financials

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Knut Gezelius, lead portfolio manager of SKAGEN Global argues that while financials are still unpopular, many banks are now overcapitalised, therefore offering an attractive investment opportunity. 

Since the 2007-2008 financial crisis, financial companies have been losing popularity among global investors. However, the lower prices for financial equities are now creating new opportunities. At the end of February, four of the ten largest holdings in SKAGEN Global were from the financial sector.

Financial enterprises – which include banks, insurance companies and real estate companies – account for around 20 percent of the world index (MSCI AC). This is five percentage points less than in 2007 when this sector accounted for one quarter of the global index.

Weighting up in financial companies
For SKAGEN, the reverse is true . At the end of May 2007, financial companies accounted for almost 18 percent of the global equity fund
SKAGEN Global, whose benchmark index is the MSCI All Country World Index.

This was around seven percentage points less than the benchmark index. By the end of February 2015, however, financial companies accounted for 28 percent of the portfolio, an overweight of seven percentage points relative to the benchmark.

Less popular
As a consequence of the financial crisis, investors have become more cautious about buying equities in banks and insurance companies. The valuation of financial companies, measured as price to book value (P/B), has declined considerably, from more than 2 in 2006, before the financial crisis, to 1.2 at the end of 2014.

The lower price tag has created opportunities for fund managers like SKAGEN that are keen to buy equities in low-priced, high-quality companies with the potential for repricing.

In the years since the financial crisis, several banks and insurance companies in both the US and Europe have built up substantial capital buffers. As times have improved and conditions normalised, many companies are now well-capitalised. Increased regulation and a more prudent approach by many financial companies boards and management have caused many companies to take on too much capital.

As a result, they are over-capitalised. We investors can benefit from this by selectively investing in banks and insurance companies as the dividend potential increases.

Good potential
American Citigroup is an example of a crisis-stricken bank that has now made a recovery. This is one of the world’s largest commercial banks, with activities in more than 100 countries. Citigroup was rescued by the US government during the financial crisis.

Since then, the bank has been brought back on an even keel and the US government sold the last of its equity holdings in December 2010. The bank’s capital plan recently got the green light in the Federal Reserve’s stress test of US banks. This will enable Citigroup to increase dividends to shareholders, or buy back its own shares. We estimate the share price’s upside to be over 40%.

AIG is an insurance company that has made a strong recovery. This company was at the epicentre of the financial crisis in autumn 2008, and was rescued by the US government with a bail-out package to the tune of $180bn. New management subsequently came on board, and for the last four years has worked to fundamentally restructure the company and reposition the strategy from unrestrained growth to
increased profitability.

The US government divested its shares in the company in 2012. AIG is currently priced as though the company’s low return on equity will
continue for several years to come, which is not an opinion shared by SKAGEN. On the contrary, AIG has good opportunities for sustained higher returns on equity, at normalised levels, which should have a positive impact on the share price development.

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