Two reasons to add exposure to banks

If you’ve been underweighting financials, it may be time to change your investment approach.

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“We remain underweight in banks, but less so than over the last few years,” says Gary Chapman, senior portfolio manager and managing director of Canadian equity at Guardian Capital. He’s one of the managers of the Renaissance Canadian Growth Fund.

He finds banks are falling back into favour for the following two reasons.

1. Loan losses have dropped below long-run averages, says Chapman. “[Losses] may not reverse course in 2015, but they are less likely to provide a tailwind for banks. They’ll also eventually begin to rise, perhaps starting with energy loans.”

Read: Canadian banks exposed to oil sector’s decline

2. Banks may participate in upward price-to-earnings multiple revisions, “owing to the persistence of low interest rates. In addition, bank dividend yields are enticing in the context of very low 10-year government bond yields.”

Read: Don’t overlook mid-cap stocks

Still, Chapman expects it will be difficult for banks to grow revenues in the current slow-growth environment. They’re dealing with heavily indebted consumers, he notes, “which is making it difficult for banks to exploit the revenue-expense gap to leverage earnings. When revenues are growing nicely, it’s easier for banks to keep expense growth lower than revenues, creating operating leverage.”

Read: How the target inflation rate affects your life

Currently, Canadian banks offer 400 basis points, or 4% yield, while 10-year bond yields are 1.8%. So, says Chapman, “we reduced our underweight [in March] by adding to our bank positions.”

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