Exchange Traded Funds (ETFs) are mostly promoted as building blocks to construct, maintain and rebalance long-term investment portfolios. In the portfolio core, broad-based ETFs provide low-cost exposure to the main asset classes and the market return. As portfolio satellites, thematic or sector ETFs provide costlier exposure to niche assets and potentially higher returns.
This core-and-satellite approach makes sense for long-term investors. For active investors, ETFs can also be used as portfolio ‘tilts’ to capitalise on volatility.
I favour using ETFs to buy parts of the market that become badly oversold during volatility. Rather than pinpoint individual stocks – and take on company risk – the goal is to ‘buy the sector’ using an ETF and position for a recovery.
The banking sector is a case in point. I have had a positive view on global bank stocks since mid-2020, principally due to falling valuations during COVID-19 and, later, rising interest rates.
As interest rates rise, bank Net Interest Margins (the difference between interest received and paid) tend to expand, aiding bank earnings and valuations.
This relationship is not always as clearcut as it seems. Other factors affect bank valuations beyond the outlook for NIMs. Interest-rate rises also dampen credit demand and increase the risk of bad debts and insolvencies as economies slow.
That said, bank stocks, particularly those in Europe and, to a lesser extent, the United States, looked cheap in late 2020, amid record-low interest rates at the time.
As inflation fears grew last year, and central banks responded with rate rises, bank stocks rallied. The MSCI World Bank Index – a barometer of 76 bank stocks – rose 32% in calendar-year 2021 (in US-dollar terms). The index fell 11% in 2022.
Global bank stocks have been belted this month after Silicon Valley Bank and Signature Bank in the US collapsed, and as UBS bought the troubled Credit Suisse as Swiss authorities raced to avert a banking crisis there and restore confidence.
Markets feared that rapid rate rises by central banks would eventually break something. They did: a few poorly run banks were first to go.
Will more follow? Probably. But it’s hard to believe these banking failures are on anything like the scale of the 2007-09 Global Financial Crisis. Banks, generally, are better regulated and capitalised today and have greater liquidity.
That’s not to rule out further short-term underperformance in key bank indices. Volatility in the sector could remain high in a jittery market.
But the problems look more like isolated incidents among a small group of poorly run banks rather than systemic, sector-wide issues. Australian banks are relatively among the best capitalised in the world, yet they, too, eased in March.
Here are two ways to take advantage of weakness in global bank stocks. I emphasise that these ideas suit experienced investors who have higher risk tolerance and can withstand volatility and the potential for further short-term losses.
- BetaShares Global Banks ETF (Currency Hedged) (ASX: BNKS)
BNKS tracks the performance of the NASDAQ Global ex-Australia Banks index (AUD hedged as it is bought and sold on ASX like a share. The ETF provides exposure to 60 bank stocks. About half of BNKS is invested in US and Canadian bank stocks.
I favour BNKS for a few reasons. First, it excludes Australian banks. That’s important for local investors, many of whom hold Australian bank stocks directly. Always check that an ETF does not replicate your direct stock holdings.
Second, BNKS is currency hedged. With US interest rates close to peaking (closer now after the US bank failures), the Greenback could finally lose some steam against a basket of other currencies. BNKS eliminates currency risk, meaning local investors don’t have to worry about the risk of a rising Australian dollar against the US dollar.
Third, BNKS holds some of the world’s largest stocks. When volatility is high, it pays to stick to the biggest and the best. Granted, the 2007-09 GFC showed that even the greatest banks are not immune when contagion spreads. But as I wrote earlier, these mostly mid-tier bank failures are not on the same scale as the GFC.
The fourth factor is valuation. BNKS has fallen 18% from its 52-week high of $6.94 to $5.67. At end-February 2023, BNKS was on a forward Price Earnings (PE) ratio of 8.8 times and price-book ratio of 1 times. Both metrics were attractive then and would be more so now after the sell-off in global bank stocks this month.
Chart 1: BetaShares Global Banks ETF (Currency Hedged)
Source: Google Finance
- BetaShares Australian Major Bank Hybrids Index ETF (ASX BHYB)
Hybrids issued by banks and other companies were also caught up in Credit Suisse’s shotgun marriage to UBS.
The decision by Swiss regulators to prefer lower-ranking equity investors over those in hybrid securities rattled hybrid markets. The move reportedly wiped off an estimated $US17 billion in the value of Credit Suisse hybrids.
Hybrids combine elements of debt and equity. In the event of a default, equity holders take the first hit, followed by additional tier-one (AT1) hybrid securities and other forms of debt. But in the Credit Suisse deal, ATI holders, who were expected to rank above equity investors in the capital structure, were obliterated.
That rattled investor confidence in AT1s. Markets feared that retail investors would dump their hybrids – or that hybrid risk would have to be repriced substantially, given that authorities had overnight changed the natural order of things in their AT1s.
Predictably, the European Central Bank and Bank of London later calmed market nerves when they reaffirmed the rights of bondholders during a banking crisis.
But the Credit Suisse news was enough to hammer the Australian hybrid market, even though our hybrids are a world away from the problems overseas. Australian banks are the main issuers of hybrids in the $43-billion hybrid market on ASX.
If a similar problem to Credit Suisse occurred in Australia, our bank hybrids would convert to ordinary shares before any write-off (which would be a last resort).
The debate seems academic anyway given the strength of Australia’s banking system and the structure of our hybrid market.
The BetaShares Australian Major Bank Hybrids Index (BHYB) has fallen from a 52-week high of $10.09 to $9.75. It’s not a big fall in the scheme of things – and a sign that the events in European bank hybrids are unlikely to be repeated in this market. But there’s better value now in hybrids for long-term investors.
BHYB owns hybrids issued by Australia’s big-four banks. BHYB’s gross running yield (including franking) at end-February 2023 was 6.27%. That will appeal to income investors who prefer the lower risk of bank hybrids compared to owning bank shares.
Chart 2: BetaShares Australian Major Bank Hybrids Index
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 29 March 2023.
