Financials the most overlooked sector in Europe, says Ignis Asset Management

The financials sector is currently the most overlooked in Europe, says Adrian Darley, head of European equities at Ignis Asset Management.
Darley, who oversees £1.2 billion of European equities at Ignis, says investors have taken an overly macro a view of markets in recent months, retaining significant overweight positions in defensive sectors such as pharmaceuticals and telecoms but failing to spot the opportunities in the cyclical financials sector.
“The market has thrown the baby out with the bathwater when it comes to the financials sector,” he says. “Yes there are problems, but not all banks are bad. Indeed, a number of them are very attractive right now. Most of those that needed capital raised it a year ago and are now looking for growth. Lending margins are much improved from 12 months ago, which for well-capitalised banks is very good news indeed. Following strong results some of these companies have already seen share prices rise strongly but many valuations remain attractive which is at odds with most investors’ underweight positioning in the sector .

Santander and BNP Paribas, says Darley, represent particularly attractive investments at current valuations. Santander, which is trading on 8 times its 2011 earnings and 7 times its 2012 earnings, not only offers exposure to high growth markets in Latin America but has also exploited other banks’ weakness to secure a strong market position in the UK, as evidenced by its deals for Abbey National and Alliance and Leicester assets .
“Santander is a great example of a company that has emerged from the credit crisis stronger than it went into it,” he says. “Even after making conservative adjustments for risky loans, its valuation remains compelling, and could become even more so as the general economic environment improves.”
BNP Paribas, which accounts for 3% of Ignis’ Europe (ex UK) equity exposure, is similarly undervalued in Darley’s view.
“BNP is also trading on 8 times consensus 2011 earnings but its return on equity will be in the mid to high teens, which is being driven by strong earnings growth and synergies from the Fortis deal. BNP’s bad loan provision has peaked and it is paying a high dividend – yet it is trading around book value. That’s a great investment opportunity.”
Other attractive financial stocks include insurers Munich Re and Allianz and wealth manager Julius Baer, a smaller financial, which Darley says offers “a good structural play on wealth management with a clear strategy for growth in Asia and the Middle East. Wealth managers generally have no exposure to non-performing loans and they have a key growth driver in globalisation. Julius Baer has significant excess capital yet trades on a 2011 PE of less than 12x despite strong growth prospects ” Darley does, however, urge caution on those stocks which have weathered the financial storm less well, highlighting Commerzbank as an example of a company which has raised insufficient capital and is burdened with a large bad loan book.
Pointing out that Ignis’ financials exposure is not a general play on cyclicals – his funds remain underweight many industrials – Darley has sought to balance the financials weighting with a significant overweight in the defensive pharmaceutical and healthcare sector, which he says is undervalued given its strong growth prospects. Favoured stocks in this area are Roche, Novartis and Fresenius. In general, Darley expects European equity performance to be reasonably robust this year although he warns that following recent rises a short-term pullback is possible, a risk that has prompted him to raise over 2% in cash to enable him to seize any opportunities a correction is likely to present.
“Europe has enjoyed a very significant move up and is close to its December/January highs, although the worries that previously weighed on markets haven’t all gone away. That means there is a greater risk of a pullback now than in recent weeks but as ever, this will present opportunities for us as we look to exploit market anomalies.”