If there is an overriding message from European policy makers, it is that the eurozone has moved on from the nadir of its economic crisis of 2010. The problem for value-hunting stockpickers in the region is that markets have too.
Europe has in many ways justified its status as a top pick for asset allocators – the DJ Euro Stoxx 50 having climbed 22% in the three years to 16
June, while the broader FTSE Europe index was up 27%.
In the same period, the average fund in the IMA Europe ex UK index achieved an impressive 31% total return, so it is no surprise that professional investors are now considering trimming their holdings.
For two of the directors within F&C’s European equities team – David Moss and Sam Cosh – it is three core tenets of quality, value and management which continue to hold sway, even if its markets are no longer so cheap.
Tougher calls
Cosh, who runs the team’s European Small Cap SICAV and European Assets Trust, admits it is getting harder, particularly in financials and peripheral Europe, which were the “obvious pockets of value” two years ago.
“Leading indicators have improved, as have credit conditions, but to get further upside from here you need to see earnings improve, with valuations currently fair I would say”, he explains.
The F&C European equities team and its processes have evolved over the past five years, with the funds previously managed by a separate team based in Scotland. Moss has been with the group since the mid- ’90s, while Cosh joined F&C in 2010.
“It’s one investment process and one team across all the portfolios, which means we get the benefits of the team,” says Moss.
“Unlike some places where the small-cap team sits in one corner and the income team in one corner, and growth in another, our process drives all our portfolios. In all the portfolios there will be ideas where I’m the analyst, or Sam is the analyst or
Mark [Nickols, manager of European Growth & Income Fund] is the analyst.
“There is very high commonality across the holdings in the all-cap funds, which are predominantly large cap, and across small-cap funds, obviously because Sam manages them.”
Cosh’s small-cap universe is around 3,000 companies, and he stresses that when the managers talk about risk, they are not talking about volatility rather the risk of permanent capital loss.
“Good assets at good prices should preserve capital during tough times,” he says.
“Surrounding all this is the belief that bottom-up stock selection will override trying to predict what is going on with the macro economics.
Predicting what politicians are going to do is a pointless game, and even if you do get it right it doesn’t tell you about stockmarket direction.”
A steady course
Cosh lists ignoring market noise as the hardest part of investing, stressing that going through difficult periods of performance should not influence the way a manager invests going forward.
He explains: “I had a lot of questions from the board of the European Assets Trust in 2010 when I started investing in Ireland, but we were able to explain that these are good assets with management with proven track records. They are not necessarily
Irish businesses anyway; they are extremely cheap and in the long term that would yield good returns. We were actually surprised about how well they did in 2011 for us, and I still have a decent position in Ireland.”
European Assets Trust currently holds around 18% in Irish-domiciled stocks, and stocks it has held include food producers Glanbia and Origin Enterprise and builders merchant Grafton.
Moss reiterates that good stock selection is about understanding the fundamentals of a business rather than focusing too much on the macroeconomics of the country where it happens to be based.
“Ireland is a good example where we have been able to buy really good businesses at good prices because others have looked at the country and thought it was a basket case and avoided it,” he explains.
“They have ignored global businesses that just happen to be domiciled there for reasons of history.”
Still, the managers acknowledge that many of the stocks that were cheap two years ago are now looking more expensive.
For the region as a whole, the emphasis is on earnings growth.
“Leading indicators have improved, as have credit conditions, but to get further upside from here you need to see earnings improve, with valuations fair I would say,” adds Cosh.
A tale of two cycles
Part of the process is taking a view on the market cycle, which he stresses is very distinct from the economic cycle. He adds: “Usually when valuation dispersion is wide there is a huge pool of value out there and you can find these great businesses at great prices because they have been abandoned.
That’s what we did in Ireland, that’s what we did in financials, and when the market recovers they will lead the way.
“At the other end of the spectrum when people are super excited about equities and banks are falling over themselves to lend, and IPO activity is at a high, then it makes sense to look for your stockpicking at the quality end of the spectrum because they won’t be priced at a premium and will hold their value better than the market corrects.”
With this in mind the pair are now focusing on building up their holdings in companies which can generate economic performance and still protect investors if things take another turn for the worst. Examples include Lindt & Sprüngli, the maker of Swiss chocolate and confectionary which offers high return on capital (3-5% per year), high margins and strong pricing power.
Another is Chr. Hansen, a Danish producer of natural ingredients for the food, beverage, dietary supplements and agricultural industry. This industry has remarkably high barriers to entry and so this company appeals for its 25% operating margins with very high returns on capital.
