The fund invests mainly in companies listed on Germany’s DAX index, with small caps comprising about half of the allocation.
Global volatility and negative sentiment hasn’t prompted him to modify his portfolio.
“Some people are deciding there is doom and gloom or they worry about the Chinese stock market when the Chinese are still learning about greed and fear,” Smith told FSA.
“I haven’t particularly changed anything. Especially when you get down into the smaller companies in the portfolio, what’s going on with global macro becomes irrelevant. A company invested in a new product or process will be able to sell it regardless of what’s going on in the economy.”
The fund has been in the top quartile of the sector during one-, three- and five-year periods, according to FE Advisory data.
Smith’s investment approach is primarily driven by valuation versus particular earnings growth prospects of a company over the next 3-5 years. He then assesses management strategy to determine if they have reasonable assumptions in budgeting and planning.
Company policy on the ESG side is also important. “Companies that continually look to save energy costs and reduce the carbon footprint, for example. The bottom line is that it saves on cost and the management has that kind of mindset.”
China’s slowdown
He admits that the fund’s top ten holdings, such as Daimler (9.5%), Bayer (6.4%), SAP (6%) and Airbus (5.6%) “have a fair amount of revenues coming from China”. Therefore, chances are increasing that China’s economic slowdown will dampen earnings for the European exporters.
Smith, however, doesn’t accept the China hard landing story. “China is slowing down from strong growth. That means slower growth. It’s not going into recession.”
He believes his portfolio companies will still perform well. Last year when China auto sales were down, Daimler had double digit sales growth every month, he said. “For auto stocks, it’s not about what the overall market is doing so much as what your products are like and where you are at in the product cycle.”
Another top ten holding, Airbus, has strong demand coming from China despite the slowdown. “Airbus has such an enormous backlog that even if cancellations came from China, it would really have to be something serious to make a dent in their backlog or impact their [profit and loss] over the next few years.”
Surprises and risks
In contrast to the market view, Smith believes the euro economies are getting more robust and the common currency could surprise this year with strength versus the US dollar.
Auto sales, he said, had strong growth in almost every country in Europe last year, coming from a low base. “It’s quite possible we’ll see a continuation of that, meaning the European economy is much stronger than people think.” At the end of the year when investors grasp that dynamic, the euro may strengthen.
“That goes against consensus and it’s what I’ll be looking out for. It might make me start shifting away from exporters and more toward domestic names.”
The single biggest risk in the next 6- 12 months is if investor confidence globally “just disappears altogether again and people talk about another global credit crunch and recession like in 2008-2009. That would effectively kill off a lot of the earnings growth”.
But he remains optimistic for earnings in 2016. “A lot of tailwinds from the euro depreciation will come through this year due to the hedging policies of companies. There is also a tailwind from collapsing energy costs. Germany doesn’t have an oil or mining sector.”
In 2016, he’s optimistic that his portfolio companies will have better earnings performance in aggregate versus the market overall.
“That’s what I’m expecting. We should see some positive performance by the end of the year even though we’re starting out on a negative note.”
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Smith is designated as an FE Alpha Manager because he has maintained a consistently high alpha score over a proven track record in rising and falling markets, according to FE data.
The Baring German Growth Fund vs its benchmark for the trailing three years:
Source: FE Advisory. Data in pounds sterling.
