Shares: Financial wave will roll on: Rising asset values is good news for the merchant banks

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AMONG the most battered areas of the stock market in the extended bear phase between 1987 and 1992 were smaller company and financial shares. The sharp recovery of the former is well-documented. Less noticed has been an equally exciting ride in financial shares, which I believe has a long way still to go.

A big factor in the strong showing is the prospect of a prolonged era of low, possibly very low, interest rates. This reduces costs, stimulates demand for financial products and enables businesses like banks to improve margins. In the US, which has had super- low interest rates for some time, banks are reporting booming profits and there has been a spectacular flow of funds into mutual funds, the US equivalent of unit trusts.

A strategy for the financial services boom that I believe is under way is to build a portfolio composed of shares from the eight sub-sectors listed in the Financial Times Actuaries Financial Group. This gives diversity, while having sufficient focus to turn in a well above average performance. On a two- or three-year view, investors should hope to double their money.

My favourite major bank share is HSBC, at 756p for the UK-traded version, but that is partly for its global and Far Eastern exposure. The more domestically oriented Barclays at 494p looks an attractive recovery play, with so much to prove after the ignominy of having to cut its dividend. One advantage for the domestic banks is that foreign banks got such a bloody nose on lending during the slump that they may not be back for a long time, reducing competitive pressure on margins.

A global trend to rising asset values is excellent news for merchant banks. They benefit twice, from the rising value of funds under their management, and from a pick-up in corporate activity as the trickle of bond and equity issues and acquisitions becomes a flood.

The big two merchant banks, Schroders at pounds 11.80 for the ordinary shares and SG Warburg at 792p, are the blue chip selections. Smaller and different is Close Brothers at 395p, which has a string of niche businesses, including the recently acquired Winterflood Securities, the smaller companies market-maker - and a remarkable record of growth in earnings and dividends.

Life insurance shares have been hit by the new disclosure rules on commissions but the better companies should ultimately benefit from the more open environment. Prudential at 327.5pand the smaller but highly successful Britannic at 430plook good choices. Among the composites, the long-time struggling Royal Insurance at 335p at last seems to be on track for recovery. Pick of the brokers is Lloyd Thompson at 337p. It will benefit from hardening rates and has consistently outperformed.

An area of spectacular buoyancy is fund management. I have been a long-time bull of groups such as M&G, at 890p, the doyen of the unit trust industry; the fast up-and-coming Perpetual at 632p, which dominates the PEP market; and Mercury Asset Management at 658p with its vast strength in pension fund management. An interesting alternative choice is Edinburgh Fund Managers at 481p, which is rapidly increasing its funds under management by a series of moves: purchase of the Target unit trust business; absorption into its EFM Dragon Trust of the twice-as-large Drayton Asia; and the current offer of shares in its new EFM Smaller Companies trust.

The last two sectors are property - where the ultra- solid Land Securities at 674p looks well placed - and investment trusts, where I go for Dunedin Worldwide at 682p, a broadly based investment trust with a truly global portfolio, including a reasonable weighting of financial shares. Latest net asset backing was 767.2p, which compares with 445. lp at the balance sheet date in 1987 and 212.3p in 1982 and has helped drive a sparkling share price performance.