Germany’s biggest lender Deutsche Bank (DBK) is on investors’ radars once again - but for all the wrong reasons. Its well-publicised problems have once against raised questions regarding the health of the European banking system. But according to Ollie Beckett, fund manager of the TR European Growth Trust (TRG), this presents an opportunity to buy European financial stocks.
“European banks aren’t that bad.” He said problems with Deutsche Bank have pulled down shares prices of European banks and other financials, but there is still value to be had in many of these stocks.
“Nobody wants to touch the financial sector at present,” he said. “When everybody is underweight in European financials and dislikes them, that’s where the opportunity is.”
Speaking to journalists in London yesterday, Beckett explained his reason for backing European financials was due to the strong capital structure of many of these banks.
German Aareal Bank AG (ARL) and Dutch bank Van Lanschot (LANS) were among his preferred stocks. Beckett predicted that Van Lanschot could provide a minimum 8% yield in 2017, supported by the bank’s strong capital ratio. Capital ratio is a measure of a bank’s capital against the risk it takes with its lending. In other words, how much loss can it sustain without running into financial difficulties.
“These banks are giving me healthy returns,” he added.
TR European Growth Trust currently has 15.7% holdings in the financial sector, compared to 12% in the Euromoney Smaller Europe ex UK benchmark. The trust’s largest sector holdings are in industrials and IT, where it has a 39.5% and 17.8% stake representatively.
Beckett also admitted that the trust’s performance was hit by market turbulence, following the Brexit vote. But he said the bought into the market as it dipped and have benefited from the subsequent bounce. However, it would be naïve to presume that the Brexit vote will not have an impact on European investment, Beckett added.
The TR European Growth Trust is currently trading at a discount of 17.6%. It gains 12.8% year to date.
Issues Surrounding Deutsche Bank and Italian Banking System
In the recent European Banking Authority’s stress test, Deutsche Bank appeared weak relative to the overall European banking system. Its adverse results of 7.8%, is shows the difficult competitive environment faced by German banks. Despite investors’ concerns about the health of Deutsche Bank, the German Chancellor Angela Merkel was reported to rule out providing any state aid for the bank.
However, Beckett said he does not believe Germany will let Deutsche Bank go down – because the country cannot afford to let the bank fail.
Meanwhile, the Italian banking system is also deeply troubled. The Italian banking system is rated poor by Morningstar’s banking system assessment, indicating that it is an unstable system and its banks do not have a competitive advantage over peers operating in the wider European region.
Beckett admitted that there are clearly issues with Deutsche Bank and the Italian banking systems, but if their problems can be resolved, these “cheap” financial stocks will continue to outperform.
Quantitative Easing is Not Going to Last Forever
Low interest rates and quantitative easing in the Eurozone are also continuing to put pressure on the profits of European banks against the backdrop of a weak European economy.
“Quantitative easing is obviously not working. I think Theresa May posed a good question – who exactly is benefitting from QE? I think we will ultimately move away from QE and move towards fiscal policy instead,” he said.
But despite predicting the end of quantitative easing in the UK, Beckett says he doesn’t think it is going to disappear from the European banking system anytime soon.
“I think there are clearly signs of quantitative easing coming to an end in the UK and in the US. But Europe is not quite there yet,” he added.
“Germany does not like quantitative easing or fiscal policy. But time will tell. When quantitative easing comes to an end, financial stocks will look more attractive.”
Do Not Invest in European Smaller Companies For Income
European smaller companies sector is where investors can find growth – which investors cannot get from large companies, said Beckett.
“This explains why many European large cap fund managers come down to this space [small caps]. They are looking for growth and that is going to continue,” he said.
“I know it is a trend that investors are looking for yields as they cannot get it from bank accounts. But don’t invest in European smaller companies for income. This is about capital growth,” Beckett warned.
“It is a weird world. Companies are almost penalised for opening a new warehouse.” Shareholders seem to prefer companies that pay out profits to investors, rather than investing in the business he said. “We need to get away from that – if we want to increase productivity in UK and Europe, we need to invest,” he said.
