UK banks were one of the most loathed asset classes among investors

[Rock Private Office]

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A combination of cheap valuations and future prospects for dividend growth all bode well for UK retail banks, according to the duo of Nick Kirrage and Kevin Murphy, who hold major positions in Lloyds, RBS and Barclays in their Schroder Income portfolio.

Until only recently, UK banks were one of the most loathed asset classes among investors thanks to their dreadful run during the global financial crisis. Very strong share price performance in 2012 has turned some heads, but they remain a big underweight across most UK equity funds.

ALT_TAG However Kirrage, (pictured), who has headed up the £1.3bn Schroder Income fund with Murphy since May 2010, says UK banks are one of his favourite areas of the market at present for a number of reasons.

Although the likes of Lloyds have had a good run over the last year or so, Kirrage believes they remain undervalued.

"Banking is the classic example of a sector that was formerly a boring, stable income play that became a basket case out of nowhere," he said.

"Now it’s on its way to not being a basket case anymore and people are starting to remember there’s a lot to like about them."

"They have huge barriers to entry and pricing power and yet you’re paying tangible asset value for them – maybe a little less. It’s a pretty ideal mix."

Kirrage and Murphy are value investors, meaning that they prioritise the cheapness of a stock above everything else. The pair head up the Schroder Recovery fund as well as Schroder Income, using their value approach across both portfolios.

Kirrage adds that banks are likely to pay dividends again soon, which will further support their share price from here on in.

"If the sector goes back to being a stable dividend-payer, that’s a whole other dimension that the current share prices are not taking into account," he explained.

"Back in 2005 and 2006, 25 per cent of the dividends in the UK market came from banks. That’s now close to zero, but it won’t be for long."

"Banks are natural dividend-payers, and I think they’ll be paying a decent yield again soon. No, I don’t think they’ll have massive headline yields, but on a five- to 10-year view, they’ll be an attractive prospect for investors who want dividend growth."