Separating 'utility' banks from financial growth stocks

Schroders' Maisonneuve sees a great big W and explains how to play financials in this mad, mad, mad, mad world.

Virginie Maisonneuve, London-based head of global and international equity portfolios at Schroder Investment Management, has just completed a visit to Asia. She speaks with AsianInvestor about how the global financial crisis has affected her top-down outlook and whether the current market rally is a dead-cat bounce.

How have your big-picture views been affected by the financial crisis?
Maisonneuve: We are at the intersection of two eras. Our long-term themes remain the same, or have been accelerated. One of these is demographics. The IMF has warned governments expanding their fiscal deficits to remember they face a pensions crisis. Another is climate change. This is also accelerating; the World Wildlife Fund has released a report saying its 2007 forecasts for the rise of sea levels is already out of date. And emerging-market growth and infrastructure spending remains in a super-cycle.

What about short-term issues?
But short term we will see more regulation. Short term, China's economy on the margin will focus more inwardly. China's exporters were fuelling the machine, accumulating foreign reserves that were invested in Treasuries; this contributed to lowering US interest rates and reduced yields, which contributed to the desire for and access to leverage. Now we are in reverse-leveraging -- not just to unwind the excesses but because China is changing its economic model. So a challenge for policymakers is how to cushion the decrease in available funding.

This is coming from the Fed.
Yes and we fear the US budget deficit could double or more. It could go to $4.5 trillion.

Over what time period?
We're not sure.

How does this affect stock picking?
We must find companies with growth at a reasonable price, with strong balance sheets, with a bias toward emerging markets, and that will benefit from our core themes of demography, climate change and emerging-market infrastructure growth.

What are the biggest challenges?
Short term, one is increased volatility in currency markets. We will also see more bankruptcies, which will create more unemployment in the West. Most companies had very strong balance sheets going into this crisis two years ago, but now they face refinancing needs. If they can't refinance, we will start to see bankruptcies. The car sector is just one obvious example.

Will US banks sell toxic assets under the Geithner 'legacy asset' plan?
That's the real issue. When we speak with the banks, they say market prices are unrealistic and don't reflect the value of those assets, and they don't want to transact. There's not been a deal to create a clearing price.

Does this mean banks will fail the US Treasury's 'stress test' and be forced to raise more capital from the government?
The trend toward nationalisation is not over. Such banks are 'utility' banks: they will be forced to lend, but unlike proper utilities with transparent tariffs, we don't know on what terms these banks will lend.

Markets have risen since Citi announced two profitable months. Have you participated in the rally?
We were very underweight financials. We've closed the gap somewhat but still keep very limited exposure to banks in the UK and Europe; we're closer to neutral in the US. Most of our re-weighting however has gone to banks in emerging markets, which have shown strong performance. In the fourth quarter of 2008, these emerging-market banks were penalised by investors but hadn't been involved in the same excesses as Western banks. We bought Chinese banks in November, then some Brazilian banks -- that brought our sector weight to neutral. We've also added defensive names such as Traveller's, Ping An and Bovespa.

Is this a dead-cat bounce -- are we in a bear-market rally?
The next 12 months will be volatile. We are not in a V-shaped recovery. It's going to look like a W, or actually a series of Ws, so there will be ups and downs -- but with a rising trend. If you have a five-year time horizon, it's a new trading pattern, but if you have a three-month horizon then I guess you could call it a bear-market rally. This is forcing us in some cases to trade more actively, and to stick with top-quality teams and franchises, such as JP Morgan and Credit Suisse in financials.

Until recently, trading volumes were very low -- how has this impacted your portfolio strategy?
We have core 'stable growers' with a three-year time horizon, and we also have opportunistic stocks, usually cyclicals. For core names, this trading environment has been all right. We'll accumulate them when we see value. For the opportunistic stocks, this environment requires you to have a strong trading desk, which we have. We take advantage of all the tools -- crossing networks, electronic trading -- and we stick to our price targets. But you are right; volumes are low, so sometimes we have to be patient.

You say the trend line for equities is a great big W; so the worst is over?
I think the momentum of negative news is slowing.

Why don't credit markets agree?
For technical reasons, and for a lack of visibility. Credit markets, credit-default swaps reflect the risk of bankruptcy. Right now the environment is deflationary. But with quantitative easing and fiscal stimulus programs, we will return to inflation -- but when? And the structural adjustments in the world economy are creating a need for companies to issue debt but at a time when there's little appetite for product.

What risks conceptually are you taking in your portfolio?
With these utility banks, they could triple in value in a short period of time; or they could go bankrupt. I can't buy these stocks, though, because I don't believe their businesses make sense. These binary decisions go against our investment philosophy. So I risk not winning big if these stocks do well. But I'd rather stick with banks and insurance companies that are very likely to do well if the general environment improves.

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