Why Fund Managers Still Like Bank Stocks

Financial stocks have been on a tear this year—and some money managers and analysts think there still are opportunities for ordinary investors.

Cheered by signs of improvement in Europe, economic growth in the U.S. and the recent $25 billion settlement among five big U.S. mortgage lenders over alleged foreclosure abuses, fund managers bought about $3.2 billion net shares in banks during the seven-week period ended Feb. 15, the latest data available, according to EPFR Global, a fund tracker.

That compares with the $199 million net shares they sold in the comparable year-earlier period, and is a stark contrast to the $15.3 billion of bank shares they unloaded world-wide over the course of 2011.

The reversal shows fund managers' growing confidence in the financial sector, which has been weighed down by fears of recession in the U.S. and the European debt crisis. The KBW Bank index of large U.S. banks is up 16% in 2012, versus 8.2% for the Standard & Poor's 500-stock index.

Much of the sector's rise is being driven by global giants such as Citigroup and Bank of America, which have surged 25% and 44%, respectively, this year.

Some big funds are reaping the benefits. Warren Koontz Jr., co-manager of the $1.3 billion Loomis Sayles Value fund, has ramped up his position in financials over the last 18 months. While his fund lost 3% last year, it is up 8.3% in 2012.

Bruce Berkowitz, manager of the $6.9 billion Fairholme Fund, has had an even bigger snapback. After boosting its stake in financials to 76% in August 2011 from 7.3% in February 2009, according to investment-research firm Morningstar, the fund plunged 32% in value last year. This year, driven by top holdings American International Group, Citigroup and BofA, the fund already has soared 20%.

Some fund managers are focusing on smaller, more-specialized firms.

Craig Hodges, a co-manager of the Hodges Small Cap fund, historically has avoided investing in financial companies. But last month he took a $2 million position in regional lender Texas Capital Bancshares, representing about 2.5% of his portfolio. Mr. Hodges says he was drawn by the stability of the Dallas company, which said in January its 2011 profit rose 104% from a year earlier to $76.1 million.

Mr. Hodges also bought 30,000 shares of Jefferies Group, the New York investment bank whose stock was battered late last year over its exposure to European debt. Mr. Hodges says the selling left Jefferies undervalued. It is up 14% in 2012.

"We thought, 'Now's a pretty good time to be sticking our neck out on some of these financial companies,' " Mr. Hodges says. His fund, with $99.4 million in assets, has gained almost 14% this year, says Morningstar.

Barry James, a portfolio manager at the mutual fund James Balanced: Golden Rainbow, avoided investing in banks or insurance companies right after the financial crisis, but lately has been buying up shares of both.

Late last year he bought into Fifth Third Bancorp of Cincinnati, and cross-Ohio rival KeyCorp of Cleveland, and in recent weeks has boosted both positions. In the past two weeks Mr. James also bought insurers Protective Life and Torchmark for the first time, and says he is considering PNC Financial Services Group and Texas bank Southside Bancshares . The fund is up 4.5% this year.

"They are not the major money-center banks," Mr. James says of his new investments. "They don't have international exposure. That's one of the things we're trying to avoid."

Plenty of fund managers remain skeptical of financials. Some 36% of 296 fund managers surveyed recently by Bank of America Merrill Lynch are "underweight" on bank positions, meaning they are investing less than their benchmarks.

"People have had a lot of enthusiasm for U.S. banks in the first few weeks of 2012, but we don't think this means investors are all in," says Kate Moore, global equities strategist at Bank of America Merrill Lynch. "It's going to probably take a few months or quarters before people feel very comfortable."

Fidelity Investments' Benjamin Hess, a research analyst who is in charge of the company's investments in financial stocks, says he saw similar interest in financials early last year, before Europe's problems spoiled the mood. He predicts the sector "will remain volatile."

Frederick Cannon, director of research at Keefe, Bruyette & Woods, doesn't advise chasing the large-bank rally. "We think you can participate without taking some of the risk," he says.

But he does see opportunities elsewhere. Life insurers, Mr. Cannon says, are attractively priced and have sales-growth potential, in part because Americans are underinsured, he says. He likes insurer Torchmark because of its cost efficiency, and likes money manager and insurer Ameriprise Financial because of its strong balance sheet.

Mr. Cannon also favors Hancock Holding in Gulfport, Miss., CVB Financial in Ontario, Calif., and other regional banks because they don't face the problems and capital constraints of many larger banks.