Tuesday, December 12, 2006

Fund Managers on Cdn Banks

The Globe and Mail, Dale Jackson, 12 December 2006

Peter O'Reilly isn't waiting for the market to tell him Canadian banks can no longer live up to investor expectations. The Dublin-based manager of the Investors Global Financial Services fund has been trimming his Canadian bank stock holdings for the past few weeks.

The fund's exposure to the Canadian financial services sector -- which includes banks, insurance companies and wealth management services -- has been cut over the past few months to less than 5 per cent of the total portfolio. "The multiple that has been ascribed to the Canadian banking sector has led it to a valuation that would suggest there are more interesting opportunities on a global level," Mr. O'Reilly said.

It's not that he doesn't like Canadian banks. His decision has more to do with bank stocks in other parts of the world that perform just as well and trade for less. "You can buy more Bank of America with your Canadian bank stocks" he said.

His global focus has paid off this year. The Investors Global Financial Services fund has returned more than 24 per cent thanks to heavy weightings in U.S. and European financials.

Here at home, investors were lining the streets for the earnings parade that ended Friday with the big six Canadian banks posting a record combined annual profit of $19-billion. Since Canada Day, the average bank share has gained 20 per cent.

But parades always look a little different from behind. Canadian banks shares now trade at close to 14 times their 2007 expected earnings -- that's good compared with other sectors, but higher than typical Canadian bank multiples of 10 to 12 times. Banks such as ING in the Netherlands and HBOS PLC in Britain trade closer to 10 times earnings.

Some Canada-based global financial services fund managers also believe domestic banks have gotten pricey. "We see Canadian banks as fully valued" said Chris Lowe, who has trimmed Canadian bank holdings in his AIC Global Advantage fund to less than 2 per cent from close to 9 per cent two years ago. "A pretty attractive valuation gap has opened up between Canadian banks and global banks."

Mr. Lowe said that unlike Canadian banks that function in a commodity-based economy, many of the big foreign banks don't carry as much single-country risk. On average, Canadian banks rely on the domestic market for 80 per cent of their business. Foreign banks including Barclays, Royal Bank of Scotland, BNP Paribas and Spain's BBVA generate half their revenue from home markets. Much of their operations are in developing markets with surplus economies such as Asia.

The AIC Global Advantage fund has returned 18 per cent so far this year.

Selling Canadian bank stocks is more difficult for Bernard Gauthier at CIBC Asset Management Inc. His CIBC Financial Companies fund is required to hold at least 60 per cent of its total assets in Canadian banks -- and he's not going a shade over. He expects earnings growth to slow in the coming years but unlike many bank fund managers, he believes generous dividend payouts make them well priced. His favourite is Toronto-Dominion Bank because he considers its growth prospects better, and valuations lower, than those of its peers.

The remaining 40 per cent of the fund is in international stocks including Barclays, UBS AG and Royal Bank of Scotland.

So far this year the CIBC Financial Companies fund has returned 14 per cent.

One true believer in the Canadian banks is Peter Gibson of Desjardins Securities. In a recent interview on Report on Business Television, he suggested the Canadian bank party may have just begun.

"This is part of a 10-year economic expansion, which means it's still early in that expansion" Mr. Gibson said.

He points to "exceptional fundamentals" and return on equity growth of up to 15 per cent as a sign the Canadian banking sector remains "extremely cheap. . . .

"They may look expensive relative to their own history but you've never seen a period like this before when you've had such a high ROE level," he said.