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Funds Exit European Financial Stocks
April 30, 2008 on 12:46 pm | In Finance |
International funds have been dropping their exposure to European financial companies as the combination of spreading credit woes and losses at major banks make managers wary of the sector.
The average exposure to the financial sector was 27.39% as of Dec. 31, 2006, according to Morningstar data. A year later it was 23.25% and it stood at 22% at the end of January.
The cap-weighted average global financial services stock has fallen 8.55% over the past year through Feb. 20. But one-month returns are 3.29%, while exposure kept on falling. This suggests the shrinkage in positions came more from managers’ active selling than depreciation of holdings.
The financials’ problems first appeared as the credit markets seized up over the summer. More bad news has surfaced since then.
Societe Generale, one of the top financial firms in France, reported a $7.1 billion loss as a result of a trader’s fraud. UBS () President Peter Wuffli stepped down as that firm posted record quarterly losses after it was forced to write off $14 billion in subprime-backed securities.
Societe Generale’s losses have fueled speculation that the bank might be carved up and sold. Swiss banking regulators have stated they won’t bail out UBS.
Both stocks have fallen sharply. Societe Generale’s ADRs peaked on May 4 at 43.20 after rising steadily for several months. It’s now at about 21. UBS peaked in April at 65.36 and has since fallen to 33.
“The key risk for these stocks is erosion in the capital base,” says Lewis Kaufman, co-manager of the $4 billion International ADR portfolio at Thornburg Investments. The Thornburg portfolio is underweighted in financials relative to the MCSI EAFE Index, which is about 26%.
Big losses at any financial institution raise questions about the way the business is run, he says.
Mortgage Woes
For UBS, the wealth management business has won praise for its sustained profits, Kaufman says. The problem is the firm’s mortgage-backed debt business.
Some European real estate markets are facing problems of their own. Similar to the U.S., a housing bubble formed in Spain, as property prices rose amid low interest rates.
“Unlike the U.S., the Spanish banks have a cushion,” said Dean Tenerelli, who manages $1.02 billion T. Rowe Price European Stock Fund. Spanish banks are required to have more capital on hand to cover unexpected losses than in some other countries.
Still, Tenerelli says European financials will likely get worse before they get better. Rather than simply cutting losses on depreciating assets, many are parceling out bad news over time. That hurts their credibility with investors, he says.
Tenerelli likes SocGen despite its problems. The fraud was an unpredictable event, and the company’s business is still profitable.
Another that he bought recently is Allied Irish Banks, () which he says is profitable and has a balance sheet relatively free of complicated debt securities.
The stock has declined 35% below its 52-week high, but Tenerelli says that has more to do with the perception of the sector than the quality of the stock.
Amid the carnage, some investors have found value in the insurance industry.
Warren Buffett’s Berkshire Hathaway () bought an $800 million stake in reinsurer Swiss Re. The ADR topped out in April at 96. It has fallen to about 70 as it wrote down losses from insuring mortgage-backed bonds.
Some funds have avoided banks entirely.
The $20 billion First Eagle Global, managed by Jean-Marie Eveillard, is one. He says the problem with SocGen and other big firms is that they are no longer in the core business of straight lending.
“Today they have all these off-balance sheet liabilities. That makes them glorified hedge funds,” he said.
Worst Not Over?
Eveillard also isn’t convinced that the worst is over. “We are not at the point where we are interested in sifting through the rubble.”
He says institutions’ revenues could keep slipping because the structured finance products brought in so much of it.
With the structured products not selling, that revenue disappears.
Oberweis International Opportunity Fund portfolio manager Ralf Scherschmidt says he has increased the exposure to financial stocks, but not banks or brokerages. He has taken stakes in exchanges, which do well even in bad markets.
“Trading isn’t going to go away,” he asserted.
The fund has a 10% weighting in financials, still below the S&P Citigroup Small Cap Growth Index, which is 18%. That’s up from the 3% it was the previous quarter.
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