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Super funds push ‘vulnerable’ bank stocks into stratosphere, elevating risk levels

The super funds' collective willingness to pay inflated prices for bank shares is starting to make them look like outliers. With about 30 per cent collective ownership of the banks, APRA sees "stability risk" as a salient concern for all stakeholders that can't be ignored.
Analysis

Last month, I wrote about the big four banks, and how rises in their share prices potentially beyond fair value should not overly concern retired shareholders for whom the dividend flow is a crucial component of their income strategy.

I pointed out in the article that analysts thought the big four bank stocks were over-valued, and trading well above analysts’ consensus price targets after outperforming the S&P/ASX 200 index by an average of about 20 per cent.

This holds true, but retirees aren’t the only holders of bank shares. And they’re not the only ones assessing the risk of a big four bank re-rate.

  • Much of the buying appetite for bank shares in recent years has come from superannuation funds. The super funds own 29.7 per cent of the shares of the major Australian banks, as at September 2024, says Morgan Stanley, and the broker expects that proportion to have risen when the December 2024 data is released in March. Super funds’ ownership of the bank sector has risen by 6.5 per cent since September 2023.

    Large super funds favour bank shares both for their long-term capital gain prospects, and because, like SMSFs, they receive refundable franking credits to the degree that they pay pensions to members.

    Morgan Stanley says there are several reasons for the super funds’ willingness to buy more bank shares.

    While the super funds are not overtly ‘indexers,’ because their investment options are regularly judged against index benchmarks, and the funds do not want to be seen to be under-performing this benchmark, they will hold positions in the banks that are close to index weightings. With the big four banks currently making up more than 23 per cent of the S&P/ASX 200, the super funds will hold positions in the banks that are close to index weightings.

    The S&P/ASX 200 index is highly concentrated and has become over-exposed to the major Australian banks. Meanwhile the super funds have continued to load up on bank shares at objectively inflated prices. Morgan Stanley concludes that these super funds, along with passive flows from ETFs, are to blame for pushing ASX bank sector valuations to “extremes”.

    Morgan Stanley believes the ongoing re-rating can be attributed to the banks’ ‘safe haven’ status within the Australian market and a range of factors which influenced the flow of funds into bank shares. These include:

    1. more flows into superannuation from population growth, a strong labour market and a lift in the Superannuation Guarantee on 1 July 2024 from 11 per cent to 11.5 per cent;
    2. more flows into equities generally, with a skew to larger-capitalisation stocks;
    3. flows from active to passive strategies, including more flows into ETFs rather than managed funds;
    4. industry funds managing more funds in-house and asset allocation teams at industry funds increasing their exposure to banks;
    5. some rotation from China into other Asian markets, including Australia; and
    6. active Australian institutional investors reducing underweight positions in banks, and shifting from other Top 20 Australian companies into bank stocks.

    Last buyer standing

    The super funds’ collective willingness to pay inflated prices for bank shares is starting to make them look like outliers.

    While superannuation net buying has heavily influenced sector performance and arguably pushed sector valuation to extremes, offshore investors – and more recently, households – have actually been net sellers of bank shares.

    As for active managers, there is a “lack of appetite at these valuation levels,” says Morgan Stanley; and similarly “the continued support of (the banks’) multiple is not being driven by offshore investors.”

    If the buying is only coming from super funds and passive/ETF vehicles following the index, what could happen if those market sectors lose interest in continued buying of the banks? Relative to their average P/E levels, Morgan Stanley says the big four banks have prospective P/E ratios between 70 per cent and 150 per cent higher (with Commonwealth Bank being at the high end), and these elevated P/E multiples already factor-in any upgrades to consensus forecast earnings.

    Any “fatigue” in funds flow from super fund/passive investors could see the banking sector “vulnerable to derate,” says the broker. In other words, the share prices are riding for a fall.

    So what could this mean for the super funds and their members?

    I wrote in December that for many long-term retail holders of bank shares, the super-charged yields resulting from the combination of a zero tax rate, refunded franking credit rebates and low average purchase prices on their individual holdings are the bedrock of their retirement funding; and that such investors are not overly worried by share price fluctuations.

    But other investors – such as super funds – do have performance competition to think about, and many of these investors are watching for a switch in sentiment.

    One issue sitting in the background, says Morgan Stanley, is regulatory scrutiny on the super funds’ levels of ownership of bank equity (and debt). The Reserve Bank of Australia (RBA) has cited this as a “potential stability risk,” as has the Council of Financial Regulators (CFR). A review by the Australian Prudential Regulation Authority (APRA) has been flagged for later this year.

    It would not take much to change sentiment toward the banks; but in Morgan Stanley’s view, increasing regulatory scrutiny on super funds’ ownership is one potential spark that could trigger a de-rating of bank P/E ratios back to more normal levels, and one that can’t be ignored.

    James Dunn

    James is an experienced senior journalist and editor of The Inside Network's publications.




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