Lilley has adopted a pro-cyclical positioning in his Old Mutual European Equity Fund, running overweights to banks and vehicle manufacturers. He is underweight all defensive sectors apart from pharmaceuticals.
“People have been piling into the quality comfort stocks for some time now and they’re overcrowded positions,” the manager said.
“In an environment where there’s fear and uncertainty, people tend to cling onto the things they feel most comfortable with. As that fear starts to mitigate, they’re not the types of stocks you want to be holding.
“At the other end of the table, there are stocks that look very cheap. I’d rather have those kind of stocks than the ‘teddy bear’ companies, as I call them.”
Lilley has allocated about 16% of the fund to banks, compared with an average of around 8.5% for the IMA Europe excluding UK sector. He owns names such as BNP Paribas, BBVA, KBC, Santander and Deutsche Bank.
“They’re too cheap. The market’s pricing a lot of risk into banks. Eurozone banks are trading on price-to-book of about 0.6. They were trading at two times a couple of years ago,” he explained.
“I think the environment will start to change as time passes. They’ve been deleveraging over the past couple of years to boost their capital ratios and in some cases that’s now finished. That means there’s less drag on growth and returns should start to move towards a more normal level.”
Lilley has also build up an overweight to “ludicrously cheap” auto makers such as Volkswagen, BMW and Renault. While European car sales have been weak, better conditions in the US and China help to strengthen these companies, he added.
The manager will be watching economic data closely as 2013 comes around to see if Europe can secure a sustainable recovery. He noted that countries such as Spain and Italy are seeing labour unit costs come down to more reasonable levels which should bolster their competitiveness.
Furthermore, relative strength in the US and emerging markets will lead to greater demand for European-produced goods and offer some benefit to the region’s businesses, despite concerns over the area’s macroeconomic outlook.
“The market’s cheap, economic growth should start to come back by the middle of next year and in that environment more financial and cyclical-oriented companies should do better,” Lilley concluded.
