Nick Dowell took on the HSBC European growth fund back in 2007 with the aim of improving returns, which had been indifferent since Chris Rice left in 2002.
To differentiate the portfolio from peers seeking index plus returns, Dowell introduced a 25 by 4 per cent approach the following year, claiming this number of stocks provides more than enough diversification. It also typically gives a mid and small-cap bias relative to many peers, which boosted performance in the post-March 2009 market rally.
The process also enforces a high hurdle rate for companies to get into the fund, with every position meeting exacting criteria for inclusion.
Performance has clearly picked up under this system, with the fund now top quartile in the European ex-UK peer group over one and three years and recently winning an A rating from S&P.
“For us, it is easier to find and manage 25 stocks than it would be with 75 names. The 4 per cent set weighting also takes away any calls on position size,” says Dowell. “We are disciplined in keeping to these 4 per cent exposures and will top up or trim positions as they rise or fall, with respective 4.5 per cent and 3.5 per cent limits.”
Dowell will sometimes hold a few stocks to represent a single position, owning two Spanish media stocks, for example, to spread risk.
He begins with a universe of around 450 companies, filtering this by return on invested capital and earning before interest and taxes yield, and basically seeking quality stocks on cheap valuations. He takes the top two quintiles based on these measures, cutting the list to 150 stocks, and then analyses these remaining companies – using criteria such as Porter’s five forces – to get to a favoured 50 businesses.
The team will meet these firms to assess factors that could affect future profitability, such as barriers to entry, pricing power and broader market changes.
Holdings in European growth are split into two broad strands – compounders and improvers.
“Compounders are stocks with a clear sustainable comp-etitive advantage we consider undervalued by the market. One example is Novo Nordisk, a pharmaceutical company that consistently reinvests profits to grow the business,” says Dowell. “Improvers are firms where we feel a potential increase in returns is under-estimated by the market.”
One such firm is Ingencio, the handheld payment terminal business expected to increase its returns through acquisition and product development. Dowell believes the company is benefiting from changing payment trends in Western markets and growing consumerism in areas such as Brazil.
Other strong performers have included Syngenta, the Swiss agribusiness that is a market leader in crop protection, and Wacker Chemie, which manufactures polysilicone for solar panels. Wacker Chemie is benefiting from a global move towards renewable energy, says Dowell.
As a focused stockpicking portfolio, exposure to renewables or emerging market growth are not deliberate themes. But Dowell acknowledges that changing demographics in emerging regions – from rising levels of Diabetes to changing food patterns – are driving growth in many of his holdings.
On the macro front, Dowell says Europe is nowhere near as bad as many believe, citing strong growth stories in Germany, the Nordic countries and Switzerland. He says: “There are some problems in countries such as Spain and Portugal but these are offset by cheap valuations and many companies are currently trading on a double discount, for being in Europe and then in Spain, for example.”
Dowell says many stocks are too cheap to ignore, with Spain and Portugal both benefiting from tailwinds through longstanding links with Latin America.
He says: “A company like Galp is listed in Portugal but derives most of its growth from elsewhere, with a large portion of its assets in Angola and Brazil. The company’s share price fell substantially in 2010 on the back of the country’s debt issues but it is effectively a regulated utility.”
For Dowell, many companies across Europe are in good shape, generating cash and having paid down debt, and opportunities are rife as valuations continue to reflect largely irrelevant sovereign issues in share prices.