As a retiree with a SMSF and in pension mode, I am definitely over weight in the banks. I am familiar with your income portfolio, but no other businesses come CLOSE to the banks, (except Telstra) in terms of consistent dividends, high yield, fully franked and well managed. There is a 2 -3+ % difference in gross yield! Some say to diversify to spread the risk, (with the consequence of a lower return), so as to average out the bumps. The banks are the cornerstone of the economy, they invest/loan funds to businesses. If an industry or major company falls upon bad times, their share price falls, AND, as the banks are investors to these companies their share price in turn falls; the opposite occurs in good times. If I view the banks as a VERY LARGE DIVERSIFIED fund manager, paying great returns, why should I diversify to another company with less returns?
A: Thanks for the question – and it is a very good one.
The argument for diversification away from the major banks goes along the following lines:
- Banks globally are increasing their capital ratios. This impacts Australian banks because APRA has adopted a recommendation from the Financial Systems Inquiry that our Banks should be in the top quartile by global standards. Having more capital ultimately means a lower ROE (return on equity), and pressures dividend payments. If they can’t generate the capital organically, they maybe be forced into another equity issue through a rights or entitlement issue. In terms of share price impact, this would be pretty material.
- Banks are struggling to grow revenue. As interest rates get crunched, this becomes even more difficult because margins fall. You can’t pay depositors less than 0%, so effectively, the net interest margin comes under pressure as lending rates are lowered;
- Bad debts are at historic lows. If the economy continues to grow only at a moderate pace, or certain sectors (such as the mining sector) come under pressure, bad debts are likely to rise.
- In Australia, we aren’t immune from the pressure of other markets. In both Europe and the USA, but more so Europe, financial stocks have had a horrid year on markets. Rightly or wrongly, we tend to follow these leads.
If you are a long term investor who isn’t worried about the market value of their bank shares in the short term, then I don’t think you need to diversify per se. However, you do need to be able to accept the following:
- ROE will fall. It is more than likely that there will be small cut to dividends (for example, NAB will possibly follow ANZ’s lead).
- There is still a risk of a capital issue. APRA has said that it won’t finalise its position until the end of 2016, but the market will be “pressuring” the banks. Expect a number of persons with vested interest to feed stories to the media about this; and
- Until bank stocks on the European market stop falling, it will be very hard for Australian bank stocks to make much headway.
