So you want to invest in UK and European bank shares: Seriously?

When we think beyond PEs and NTAs and whatever other sanitised numbers the market looks at and focus on the actual nature of banking as a business and what is going to protect our downside if we are wrong; we inevitably throw banks onto the too hard basket with regard to being genuine long term investment prospects.

We regard banks as being businesses with the following common characteristics:

• Low ROAs;
• Low transparency;
• High leverage;
• Economically sensitive;
• Cyclical;
• Generally disliked by their customers; and
• Trapped, a bit like mice on a wheel, relentlessly selling homogonous, commoditised products.

Not much has to go wrong for any business with these characteristics, for their equity to be wiped out.

The differentiators are credit culture and maybe, to lesser extent processing costs. We find the cost argument as being conflicted though because, if you believe you have a cost advantage you will push aggressively for scale to leverage this advantage and on some level inevitably (we think) you will compromise on credit.

Given the inherent leverage banks carry in their capital structures valuation measures like PEs or NTAs are meaningless to us with regard to offering downside protection of equity values. The people selling bank shares at todays prices are more than aware what their share prices have done recently and what the market thinks of their current valuation.

Maybe there is an argument that extended quantitative easing has had its desired effects and the system has healed… and therefore it makes sense to deploy capital into the banks today. Our concern though is all it has really done is just papered over the cracks, in which case the volatility we have seen since the Brexit vote is going to be with us for a while longer yet.

Fund Positioning 31_05_2016