Schroder Recovery managers discuss UK banks, July 2016

UK banks: the most attractive value opportunities in the world

We've seen some monumental changes amongst those who run our country recently, so it's nice to talk about two colleagues who, instead of in-fighting, have managed money together successfully for more than a decade now.

This week, Nick Kirrage and Kevin Murphy celebrate their 10 year anniversary running the Schroder Recovery fund, which is on the Chelsea Selection. Here, they discuss why they think UK banks are the most attractive value opportunities in the world.

“We are the most deep value fund in the country,” begins Nick. “More than 80% of our stocks are considered 'value opportunities' - essentially those on very low valuations. We aim to cherry pick the cheapest companies with the best potential for improvement. Many of these stocks may be out of favour or beaten up by the market, but we look through the market sentiment to the long-term possibilities.

“We invest this way because it has been shown that over the long-term, through many market backdrops, that what you pay for a stock is the biggest driver of future returns. Value is key no matter how you cut it.”

“You cannot make money for clients if you don't take risks,” he continues. “But you need to be sensible. When we look at a stock, we look at 'worst-case-scenarios', assess the likelihood of each, and assess their affects on company performance and share price. This way, we can look at the balance between potential upside and the likelihood of any further falls.

“Post the EU referendum, we are re-evaluating a number of stocks as sectors as there has been a dichotomy in the market reaction: by and large, the UK's largest companies have increased in value whilst our medium and smaller companies have been hit quite heavily. House-builders are a good example. They were hit heavily after the Brexit vote and are about 30% off their peak prices. However, in our opinion they are still overvalued. Taylor Wimpey is interesting at 50p, but not at 200p.

“Similarly, banks are very much in the news at present. We have about 16% of the portfolio in UK banks across 5 different names. We now believe these are the most attractive value opportunities in the world. There are many parallels between the banks now and the tobacco companies in the mid-2000s, when people assumed they were in terminal decline.

“Bank stock prices are at 2009 lows, despite having three times the capital protection they did prior to the downturn. These assets are clearly cyclical (dependent on the economic environment) and while they will have some bad loans in the coming months, their balance sheets are demonstrably better than in '09, yet they are being valued at the same price.

“Away from banks,” he concludes, “we have been steadily cutting back our mining stocks after their bounce in the first half of this year.”