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People use automated teller machines (ATMs) of Portuguese bank Banco Espirito Santo in downtown Lisbon July 11, 2014.

RAFAEL MARCHANTE/REUTERS

The Canadian fund manager betting big on a European banking recovery isn't cutting and running after the Portuguese tremors. He's even more convinced that this is the time to buy.

In January Streetwise wrote about a new fund created by Hamilton Capital, designed to ride the recovery of Europe's financial system. At its core, the investment thesis was rooted in fundamentals: economic growth was coming back and loan losses were falling.

It all made sense. Yet six months later the early returns aren't so encouraging. Since inception the fund is down 4.5 per cent – but has beat its benchmark by 1.8 per cent – and now there are fears that Portugal's Banco Espirito Santo, the country's second-largest bank, is teetering because its parent company has filed for creditor protection.

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Someone who's timid might simply change strategy. Rob Wessell, the fund manager who runs Hamilton Capital, swears there is even more support today for his underlying thesis.

Those BES fears? Overblown. The problems faced by the bank and its parent company "are small in the context of the overall eurozone," he wrote in a note to clients. BES's €83-billion ($120.6-billion) in assets don't add up to much in a sector dominated by banks with €1-trillion worth of assets or more, and Portugal's gross domestic product amounts to just 1.5 per cent of the continent's total.

Mr. Wessel argues his fundamental thesis makes even more sense today.

Since January, euro zone bond yields have fallen dramatically, which generally suggests investors are more confident about the recovery. Lower yields typically signal that investors are more confident about GDP growth, and that can only be good for banks. From January to June Greece and Portugal's 10-year bond yields fell 185 basis points and 165 basis points, respectively.

The European Central Bank has also adopted looser monetary policies in the past month, such as implementing negative deposit rates for excess reserves and dropped its refinancing rate by 10 basis points to 0.15 per cent. Better yet, the ECB implemented a new long-term refinancing operation (LTRO) which is designed to help even more banks borrow money cheaply, so that they can lend to businesses to stimulate growth.

Europe's banks have also proactively raised capital ahead of the stress tests this fall, and investors have been willing to step up and buy the rights offerings.

None of this is guaranteed. Even with its solid capital levels, BES's problems could be deep-rooted they could be enough to make other euro zone banks cautious about lending again. The region's recovery is still incredibly fragile and fear is contagious – which is why so many people are worried.

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Mr. Wessel also isn't naive.

"GDP growth is tepid. Loan growth is very low, with many banks still running off large non‐core portfolios. Margins are depressed with extremely low interest rates. Certain large banks still have government ownership," he wrote.Mr. Wessel isn't naive. "GDP growth is tepid. Loan growth is very low, with many banks still running off large, non-core portfolios. Margins are depressed with extremely low interest rates. Certain large banks still have government ownership," he wrote.

But he is still more than happy to take the contrarian bet – something you don't hear much about because doom and gloom headlines are much more tantalizing.

"Investors will no doubt recognize that virtually all of these conditions existed with U.S. banks in early 2010, after which bank stocks rose 70 per cent as growing profits/tangible book values, combined with multiple expansion, produced abnormally high returns over the following four years," he wrote.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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