European bank ETFs on the rise but can performance continue?

Feb 22nd, 2017 | By | Category: Equities

ETFs tracking the European banking sector have made consistent gains since June 2016, as shown by the Lyxor Stoxx Europe 600 Banks UCITS ETF rising 46.7% since its multi-year low in early July 2016. The turnaround followed a one year period of misery where the industry lost approximately 50% of its market capitalization. While an improving European economy and the expectation of higher interest rates has served to buoy share prices, the sector faces significant risks going forward.

European Banking ETFs

The Lyxor Stoxx Europe 600 Banks UCITS ETF (EN PARIS: BNK) is up 46.7% since its multi-year low on 7 July 2016.

European banks have been posting their Q4 2016 earnings results over the past few weeks. The figures were a mixed bag but have been viewed as generally positive.

Some notable names reporting strong performance included Spanish behemoths Banco Santander and Banco Bilbao Vizcaya Argentaria, Swiss heavyweight UBS, German Deutsche Bank, and Dutch giant ING Groep.

HSBC shocked the markets however by falling massively short of analyst expectations and reporting annual pre-tax profits had crashed by 62%.

The Italian banking sector, although under less pressure than its crisis point at the end of last year, is still being weighed down by the impact of a mountain of bad loans. Italian lender Banca Monte dei Paschi di Siena, the world’s oldest bank, had to resort to a government bailout in December in a bid to keep above water.

Despite these cases, investors are increasingly optimistic about the European banking sector owing to the improvement of several key fundamentals. An improving Eurozone economy with stronger GDP growth and falling unemployment rates have boosted the return to lenders.

Banking stocks are also benefitting from the expectation that global interest rates are to be lifted in the near future, increasing the spread between borrowing and lending costs on which firms base their profits. ETFs tracking the sector recently recorded a notable jump in value on news that Janet Yellen, chairwoman of the US Federal Reserve, is intending to maintain the Fed’s strategy of raising interest rates several times this year.

While the European Central Bank is not on the same schedule, the market is still assigning a 95% probability it will raise the deposit rate to -0.30% by then end of Q4 2018.

European banking ETFs are also riding on the coattails of their US equivalents which benefitted from Donald Trump’s victory in the Presidential elections due to an expectation of lower financial regulation.

Trump has clearly announced his intention to scrap the 2010 Dodd-Frank Act and dismiss the Volcker rule, allowing banks to re-engage in speculative activities with the bank’s own money. This has ignited fierce debate however with critics arguing the removal of such safeguards would cast the financial industry back to the overly risk-seeking culture prevalent pre-2008, and cause long-term instability to the sector.

In a note to clients, Barclays also pointed to several other potential headwinds for the European banking sector such as a softening in inflation and the possibility of political risk events, most notably in upcoming elections in France, Germany and the Netherlands.

ETFs hold many advantages for investors seeking access to European banking stocks. They are generally lower cost compared to other investment vehicles and provide broad diversification in a single wrapper. Such diversification is important to minimize the impact of poor performance from individual firms (such as HSBC’s disastrous earnings report) as well as to protect against the idiosyncratic risk of future penalties being imposed on institutions, a risk that may increase over the long term if industry regulation is indeed softened.

The aforementioned Lyxor ETF has €670m in assets under management and a total expense ratio (TER) of 0.30%. Along with the London-listed db X-trackers STOXX Europe 600 Banks UCITS ETF (LON: XS7R), the ETFs track the Stoxx Europe 600 Banks Index.

Other available ETFs include the £392m London-listed SPDR MSCI Europe Financials UCITS ETF (LON: FNCL), which tracks the MSCI Europe Financials Index and has a TER of 0.30%.

Another option is the German-listed €312m Source EURO STOXX Optimised Banks UCITS ETF (Xetra: X7PS) which tracks the Stoxx Euro Optimised Banks Index, a reference for Eurozone banking firms within the broader Stoxx Europe 600 Banks Index. It has a TER of 0.30%.

Investors looking to position for a decline in the European banking industry may wish to consider the Boost EURO STOXX Banks 3x Short Daily ETP (Borsa Italiana: 3BAS). The ETP tracks the EURO STOXX Banks Daily Short 3 EUR Gross Return Index, providing three times the inverse daily performance of the EURO STOXX Banks index. It has a TER of 0.89%. The ETP is intended for short-term tactical positioning and is unsuitable as a long-term holding.

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