Bouncing banking shares could make you see red

Anyone investing in bank shares last year was on to a sure-fire loser. With the fall out from the credit crunch compounded by recession, shares such as Royal Bank of Scotland (RBS) lost about nine-tenths of their value and led to the Government bailout of the banks.

The slide continued this year and most banks were trading at all-time lows by the end of February.

But since March there's been a big recovery; Barclays saw their share price climb more than 400 per cent. RBS has jumped almost 300 per cent, Lloyds Banking Group recovered almost 150 per cent before this week's new share offer and industry heavyweight HSBC is up about 80 per cent.

Investors who got in at the low point have experienced massive returns on their investments since March. While many are now taking profits, others are still steaming in.

Last week, stockbroker TD Waterhouse reported a 79 per cent increase in the number of bank shares bought with HSBC and RBS in the top 10buys and banks accounted for one-fifth of all deals at the Share Centre.

Despite the rush to invest, is it a wise move or is it too late to profit from the banks' recovery?

Nick Raynor, an investment adviser at The Share Centre, thinks the opportunity for short-term gains has passed: "The banking sector remains a popular trading ground for investors, as many hope to make a profit from current share price volatility.

"However, while the yo-yoing share prices have given seasoned investors plenty of opportunities to dip in and out of the sector, we are advising those new to investing to remain cautious and avoid banks for the time being.

"We believe investors have missed the short-term recovery of the banking sector, as some bank's share prices have almost trebled in the last three months. With regards to the long-term recovery this remains to be seen.

"While overall it appears the banks are starting to take positive steps to manage their debts and create capital, we are advising investors to wait for more evidence in terms of financial results that banks are performing well before buying back into the sector." It's a view that others share. Adrian Lowcock, a senior investment adviser, at Bestinvest says: "The timing of investing in bank shares is difficult to judge and the recent surge in share prices suggests some may have missed the initial recovery. Investors also have to decide which companies to buy and whether to buy the equity or debt of the company."

David Kuo, a director at The Motley Fool, says anyone who has made money on bank shares in the past few months should sell up now. He points out that while bank shares have had a decent run, most of the gains have been based on a punt on share price recovery rather than investing in a future stream of profits.

"One of the main yardsticks of investing is the price to earnings ratio or P/E," Kuo says. "It provides a useful guide as to how much the shares cost relative to every pound of profit a business generates. Currently banks have a lot of "P" but not much "E". So, investors who have made money on the recovery may want to think about locking in some of their gains."

Geoff Penrice, a senior adviser at the IFA company Bates Investment Services, thinks the volatility of the banks – which led to the price swings that allowed canny investors to cash in – means people should be wary: "Most investors would expect the banks to start being profitable at some point in the future. In the short term, however, bank shares are very vulnerable to even slight movements in the valuation of their assets or liabilities and this will cause high levels of volatility," he points out. That was highlighted on Monday when Lloyds' shares rose 6 per cent after news broke that its much-criticised chairman, Sir Victor Blank, will step down next year.

Penrice points out that the legendary fund manager Bill Mott, who runs the PSigma income fund, has historically been quite bullish on bank shares but sold most of those held by the fund in October, on concerns that the downside risk was still high. Mott is also concerned that banks are still opaque and it can be hard to get accurate information on what assets they hold.

Penrice believes that in the medium term, banks such as HSBC and Standard Chartered – which have a strong overseas presence, especially in Asia and developing economies – should benefit from the economic upturn when it happens.

"Of the UK domestic banks, the enlarged Lloyds Group has around a third of the market and so is in a very strong position. But, in summary, there will be some medium- to long-term gains from bank shares or funds which invest in them, but it could be a rocky ride over the next year or two," he says. While the short-term gains in bank share prices have been dramatic and often leading the FTSE, it's important to look at the bigger picture, suggests Richard Hunter, the head of British equities at Hargreaves Lansdown.

He points to the 12-month performance of bank shares, which don't make such pleasing reading. To the end of last week, RBS was down 87 per cent over 12 months, Lloyds was down 78 per cent and Barclays and HSBC were both down 36 per cent. Meanwhile the FTSE fell just 30 per cent over the same period.

"The market view of UK banking shares is becoming polarised. Barclays and HSBC are currently generally regarded as a hold while Lloyds Banking and RBS are, in market consensus terms, both sells," Hunter reveals.

"Lloyds Banking, for example, continues to point to the longer-term potential arising from the acquisition of HBOS, particularly in the savings and mortgage markets. In the interim, however, this very acquisition is causing additional concerns in terms of the need for additional write-downs in an ailing business, while the wider Group's life assurance business has suffered a 22 per cent decline in sales over the quarter.

"Thus, despite the recent share price recovery for UK banks, the general market feeling is that the time is not quite right to be drawn into an outright return to this continually volatile sector."

Against such negativity, there still seems to be support for banks among private investors. While that may be driven purely by sentiment, who's to say that a punt now by brave investors may not be rewarded in the future?

One solution for those backing a banking recovery could be to pick a fund which invests in bank shares, rather than risking an investment direct in the shares. Direct investment means risking the share price slumping and the loss of most of your cash. Investing in a fund means spreading the risk so that even if one bank collapses, others should help your investment.

That's what Brian Dennehy, from Dennehy, Weller & Co, recommends: "There is a lot of uncertainty around the long-term profitability of the banks, even though there is scope for positive surprises in the short term. I rather favour corporate bonds issued by banks, where you only need the banks to survive to make money, whereas shares rely on the banks not just surviving but also thriving."

He says it is difficult for private investors to access these bank bonds, so the best way is to buy a fund with a heavy concentration in banks. "I would choose Old Mutual Corporate Bond which has an estimated distribution yield of 10.1 per cent. With the average price of the bonds held by the fund being just 77p, it implies capital growth potential of 30 per cent in addition."

Adrian Lowcock, from Bestinvest also favours funds with a financial focus. "Given the complexity of banks' balance sheets and the difficult economic climate, investors should consider investing in financials as a long-term strategy and seek to diversify. I recommend getting exposure via Jupiter Financial Opportunities, run by Philip Gibbs," he says.