LONDON Hedge funds who have tried to make money out of European banks during the euro debt crisis are becoming frustrated with the sector's erratic movements just as some bigger, and more patient, institutions are dipping tentatively back in.
European bank stocks .SX7P have risen more than 25 percent since late July, fuelled by relief over new crisis-fighting plans, in particular the ECB's latest announcements which have triggered hopes of a more lasting solution.
But the sector at the root of the global financial crisis has repeatedly disappointed investors after each attempt to call a floor, from a rally at the beginning of 2009 on hopes that the worst of the global credit crunch was over to short-lived optimism over the European Central Bank's liquidity injections.
In addition, scandals and increasing regulatory demands have been shrinking returns on equity while economic recession is likely to keep loan growth on the ropes for years to come.
That has prompted at least some hedge funds to pull out, while mutual funds and other institutional investors are stock-picking only with considerable caution, reluctant to call any sustained rally in the unchartered territory of the euro crisis.
One hedge fund investor who spoke on condition of anonymity told Reuters that more hedge funds have been cutting their positions than increasing them, while some had given up altogether, viewing the sector as too opaque.
"A lot of managers feel long-term they're good holdings - society does still need banks - and valuations (are interesting). But the view is that they're less and less analysable," said the investor, who holds money in a wide range of hedge funds, said.
"I've seen a few examples where they've thrown in the towel or used banks as a source of capital for something else," said the investor, who declined to be identified because of hedge fund reluctance to detail investment decisions.
Among those to have reduced their positions is Lansdowne Partners, according to the source. Lansdowne, which runs $11 billion (6.77 billion pounds) in assets and whose $6.8 billion Developed Markets fund fell 20 percent last year, has been hurt by bank holdings. The firm, which is up 5.9 percent in performance terms so far this year, declined to comment.
Data suggests hedge funds are now scaling back both on owning bank stocks and on short positions - bets on a lower price.
Hedge fund long exposure to financials - bets on rising prices - has come down to 19.1 percent in July from 20.4 percent in February, according to JP Morgan data, while Markit data on stock-lending - a good proxy for shorting - shows positions being cut.
The volatility of banks can be particularly hard for the hedge fund sector, whose investors tend to be more fickle than mutual fund investors and can become disgruntled faster than institutional investors by poor returns.
Odey, one of Europe's best-known hedge fund firms, which made millions in 2009 when the price of Barclays shares rocketed, has also reduced its holdings in European banks from peak levels, selling some in favour of U.S. banks such as JP Morgan (JPM.N), although it still holds Barclays shares.
According to Thomson Reuters Lipper, Odey's Pan European fund cut banks to 12.6 percent of its portfolio in the six months to end-August from 20.69 percent the previous six months.
At the same time, more institutional investors, which have long seen banks as toxic assets, are considering the sector again, believing the EU's latest crisis-fighting plans offer a better chance than previous efforts of a longer-lasting fix.
"After 4-1/2 years, it's the first time I'm convinced it is worth looking at them again," said Andreas Thomae, portfolio manager financials at Germany's Deka Investment, which manages 150 billion euros (121 billion pounds) of assets.
"We think we have seen the low point in bank valuations ... in steps (the rally) can become a trend."
Despite a rebound that outperforms the pan-European Stoxx600 for this year, banks are still by far the worst performing sector in the region since the Lehman 2008 collapse, having lost nearly 50 percent.
"We do like banks.... We see a lot of financials firms that are very cheap, trading perhaps below book value but producing very decent levels of profit," said Bill Maldonado, head of global equities at HSBC Global Asset Management. "At present bank shares are pricing a very negative global economy and we don't attach a material probability to this occurring."
The European bank index is trading at about 0.7 times book value. Some banks such as Barclays (BARC.L) are valued at 0.5 times and Societe Generale (SOGN.PA) at even less.
John Velis, EMEA head of capital markets research of Russell Investments, said the firm, which has over $150 billion in assets under management, has turned from negative to neutral on banks and slightly moderated its underweight position.
"Now that things seem to be for the time off the boil, perhaps only for the short term, there is no reason to be negative Europe or the banking sector," Velis said.
But he warned that it was hard to predict how things would develop, a caution echoed by mutual funds and other institutional investors treading back to bank stocks.
Carmignac Gestion, which runs over $60 billion, is edging back after shunning bank stocks for two years. Banks now account for 5 percent of its European portfolio, said Didier Saint-Georges of Carmignac's investment committee.
"What (ECB President) Draghi has said opens up enough possibilities of a reduction of the sovereign debt risk for us to be a bit less cautious on banks," Saint-Georges said. But he added: "We are cautious and choosing banks that seem strong enough and where there is little risk of capital increase."
(Additional reporting by Joel Dimmock, Steve Slater and Sujata Rao; Graphics by Vincent Flasseur and Scott Barber; Editing by Ruth Pitchford)