Healthy FIG issuance last year could be bolstered in 2011 as investors, who have underweighted many developed-world banking stocks in the past two years, find improving conditions tempt them back to market.

Governments may dominate some banks' share registers, but they could be joined by fund managers as this important group of professional investors returns to the market in 2011.

Many fund managers have spent the past two years avoiding bank shares in North America and Europe in particular, preferring instead to invest their money in anything else as long as it had an 'emerging markets' label attached to it – and that approach has also been applied to banks.

But certain key money managers that specialise in buying shares in financial firms for their retail and institutional investor clients tentatively suggest that factors such as regulatory clarity and – where they can be found – attractive business models, bode well for the previously battered banks in Europe and North America.

Emily Adderson manages money for UK-listed fund manager Henderson Global Investors and leads the Henderson Global Financials Fund, which had £86.74m ($138m) of assets under management at the end of November 2010. Ms Adderson thinks that investment opportunities in the banks of developed economies could resurface in 2011.

"Western banks are going to be more attractive to investors, but the drivers in this shift will be things such as the clarification of regulation, namely Basel III, and the removal of sovereign risk, for example."

Ms Adderson's investment portfolio did have a high allocation to bank capital in 2010, but this was weighted towards banks in the emerging markets. Notably, however, the US, Switzerland and the UK are now the top three countries in her portfolio, according to current fund documents, with Brazil being fourth. Not all the target stocks in these countries will be those of banks, as the fund invests in other areas of financial services. And continuing the emerging market theme, Malayan Banking and Banco do Brasil both make the top 10 holdings.

In terms of her outlook for bank capital, Ms Adderson says she expects "plenty of supply and appetite" in 2011 and that there will be "some big opportunities".

What it takes to win

Big opportunities are exactly what fund managers are chasing more than ever at present. If anything, their investment decisions are driven by a hunger for yield. Seeing as markets remain volatile, it might not surprise anyone if banks were the next asset to rally. However, if banks have little control over what happens to their shares, then they have even less control over regulation and sovereign risk, which are important considerations for fund managers such as Ms Adderson.

What banks are in control of is their business model, and this is another area of keen interest to fund managers. To stimulate investor interest in their equities, banks need to refocus on business models and concentrate on the areas of business that really add value. Those banks perceived to have sustainable models with the right mix of businesses are the ones most likely to attract investors.

Gilles Costerousse, recently hired as head of Rothschild's financial institutions group (FIG) capital markets advisory, who is a former Lehman Brothers FIG banker, says that investors will be selective when considering banking equity. But winners and losers are typically easy to identify, he adds.

"Their investment criteria [are] likely to be based on picking those banks that have a balanced mix of business."

The right mix

Although some banks have been busy divesting some non-core businesses, Mr Costerousse believes that investors are more likely to favour banks with a component of retail banking, asset management and insurance businesses to them.

Jim Renwick, head of UK equity capital markets (ECM) and corporate broking at Barclays Capital, agrees that a balanced business mix would help attract investors. He says a lot of banks are changing the way they operate and reappraising business models to make themselves more attractive.

Most see this as positive, as it should ultimately result in stronger banks. But what about weaker banks – do they have a chance in any 2011 equity upturn?

"For those more troubled banks, investors will consider a variety of key factors, such as the cost of capital and the return on equity," says Mr Renwick. "Investors will always examine the portfolio of any bank when making investment decisions – the portfolio of a bank and its return on equity are correlated."

At least troubled banks may have regulation on their side. Basel III – the new rules which will require banks to hold more capital to help absorb any major losses and reduce the likelihood of failure – should give investors greater confidence in the banking sector, albeit more certainty about the amount of capital to be held is needed.

Individual stories

Guy de Blonay is another top money manager who concentrates on financial services firms, and he does not think that banks will necessarily find it hard to raise capital in 2011, pointing out that they managed to do this even during the financial crisis.

The Swiss-born fund manager co-runs the Jupiter Financials Opportunities Fund, a fund offered by Jupiter Asset Management and has £978m under management (at November 30, 2010) invested in 71 holdings.

"In Europe, banks have been able to raise capital through the financial crisis and this occurred again in 2010, as demonstrated by Standard Chartered and Deutsche Bank. So I don't see a big restriction from the market to raise capital in 2011 – we just started with two small Greek banks," says Mr de Blonay. "The question is not so much about if it is feasible or not; it is more about the price conditions and potential dilution, and this will depend on the individual equity story."

The US market

In the US, Mr de Blonay believes banks that have to raise capital will mainly be limited to those that have to repay the Troubled Asset Relief Program (TARP). Even here, he believes that they should have few problems, "Especially if they can use the raise as an excuse to solve any of their capital problems if they exist," he says.

One thing that banks will have to be clear on to attract Mr de Blonay's clients' money, however, is their financial strategy.

"Investors are more willing to invest in conversions and bank capital raises in general where management can lay out a clear strategy of what the capital will be used for," he says. "If they do not do this, the deals are less appealing."

Saying he expects a "reasonable environment" for FIG issuance this year, Mr de Blonay says that against a background of quantitative easing, "capital market activities will be driven by greater demand for risk assets and mergers and acquisitions [M&A]", and "supported by flexibility to benefit from Asian growth".

Primary and secondary ECM activity in the FIG sector will continue to be robust, Mr de Blonay says. He adds that the drivers will include the refinancing of, and placing of, big-ticket government stakes such as in Germany, the UK and the Netherlands. The reinforcement of peripheral EU bank capital will be a further driver, and M&A/corporate restructuring too – though on this latter point Mr de Blonay says many banks have been adopting a wait-and-see approach on restructuring. "But as visibility improves, and given a market rise, we should see reappraisal of competitive strengths driving M&A, initial public offerings and spin-offs."

It is clear that even if the outlook for raising finance is positive, financial institutions nevertheless now have to work a lot harder to attract investors. But FIG continues to be an important part of banks' ECM business; over the past year, many banks have made a number of hires in this sector, as seen by Mr Costerousse, whose role at Rothschild was newly created.

Moreover, FIG will continue to remain a busy area, as a number of banks will have to raise more capital. However, capital raising will not be so easy for some, with concerns over performance issues, uncertainty in the regulatory sphere, fears over peripheral sovereign debt and the lack of confidence in banks and their ability to withstand further shocks.

Cheap and tempting

Yet some investors will be tempted by cheaper shares, particularly those of certain banks that seem to have been penalised unfairly. Mr de Blonay says a number of cheap banks – such as Citigroup and JPMorgan – are still tempting investors.

Similarly, John Crompton, global head of ECM at HSBC, says: "Investors look out for opportunities to take part in bank recapitalisations at or near the bottom of the cycle, because valuations are often attractive at that point in the cycle, and if the bank's capital needs are fully met by the capital raise, then returns to investors can be attractive".

It seems this could well be the year when investors return to holding overweight positions in bank equity – but not all banks will make this list. Investors are likely to be picky and support those issues where strategies are clear and there is strong growth potential to be realised.

And inevitably as the economic pendulum continues to swing from developed to emerging world, emerging market candidates will play as strong a part as ever.

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