Edinburgh’s largest money manager for outside clients is shunning shares of European banks such as Spain's Banco Santander SA, saying the risk of losses from their sovereign debt holdings are still too great.
Banks that were “conservatively” managed and own more government bonds than some rivals will have to raise more capital as part of expected regulatory changes, Gerald Smith, deputy chief investment officer of Baillie Gifford & Co., said in an interview in Edinburgh. He prefers telecommunications companies that pay higher dividends such as Deutsche Telekom AG.
“There has been some enthusiasm for financial stocks, but I think that’s premature,” Smith said at his office. “You have still got sovereign debt issues to be resolved, you have got changes to capital requirements that will structurally lower returns as companies will have to hold more capital.”
Baillie Gifford manages 72 billion pounds ($116 billion) for seven of the largest 15 pension funds and clients including Vanguard Group Inc., the world’s biggest mutual fund company, according to the Scottish firm’s website. Its assets jumped 29 percent last year as it won new business.
Smith, 48, sold his holding in Banco Santander, Spain’s largest bank, and reduced investments in other European financial stocks at the end of 2010.
Banks are the second-best performing industry in the Stoxx Europe 600 Index of European shares so far this year, returning more than 11 percent, more than three times the overall index return of 3.3 percent. Santander returned 12 percent this year, ranking 24th of the 52 banks in the index.
“I am a little bit concerned about Santander,” Smith said in the Feb. 17 interview. “They are a European bank exposed to the Spanish market and they will be caught up in some of the same trends. I have even less in European banks than I would have done last year.”
Spanish banks may need 38 billion euros ($52 billion) of additional capital because of new government rules on capital requirements, JPMorgan Chase & Co. said on Jan. 31. Santander, based in the northern Spanish city of the same name, is counting on business abroad as bad loans and higher funding costs hurt earnings at home.
Smith, who takes over as chief investment officer at the end of April, says Spain probably won’t follow Greece and Ireland in needing an international bailout. It’s “50-50” whether Portugal will need help, he said.
The yield on the 10-year benchmark Spanish bond has fallen by 9 basis points this year to 5.36 percent. The premium, or spread, over German bunds has narrowed to 221 basis points, down from 249 basis points at the end of December.
Emerging markets are starting to look cheaper relative to other markets following declines in countries such as Brazil, China, India and Indonesia, said Smith, who was head of emerging markets at Baillie Gifford between 1997 and 2008.
The MSCI Emerging Markets Index of shares lost 2.7 percent this year, while the MSCI World Index of equities from developed markets in 24 countries rose 6.1 percent. India’s benchmark Bombay Stock Exchange Sensitive Index, or Sensex, has fallen 11.9 percent in 2011.
“We are not yet at the point we can say places like India and Indonesia are screamingly cheap,” Smith said. “But they are de-rating rapidly, so even within emerging markets we are starting to see some value emerging.”
Smith has started to invest in gold mining stocks including Canada’s IAMGOLD Corp., and Real Gold Mining Ltd., an Inner Mongolia-based producer. He changed his mind on gold when thinking about where else people might want to put their money.
“The final factor is that some central banks have started to buy a bit and that has made a huge difference in the supply-demand dynamic,” he said.
Gold mining stocks are looking quite attractive relative to the higher price of bullion , Smith said. Gold in New York topped $1,400 an ounce yesterday as unrest in the Middle East boosted demand for precious metals as a haven.
Baillie Gifford’s assets compare with 183.3 billion pounds at Aberdeen Asset Management Plc, Scotland’s largest fund company. Aberdeen increased assets 27 percent last year, according to regulatory statements.