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Euro earnings


Argonaut’s Olly Russ sees income investment as a natural fit for Europe, with companies displaying similar dividend yields and free cashflow as in the UK.

He says many investors still see the continent as a low-yield environment but that view is 20 years out of date and dividends are making up an
increasing part of total returns from European companies.

Russ and Barry Norris set up Argonaut as the first jointventure firm in partnership with Resolution in 2005.

The pair were previously at Neptune, where the latter built up a strong track record on the European Opportunities portfolio and Russ worked across various UK funds.

Russ now runs Argonaut’s £453m European income fund, with a basic philosophy that value stocks outperform over the long term and dividend
yield is a subset of value.

He tends to focus on more stable dividend-paying companies with good free cashflow, which are typically neglected by the market and therefore cheap.

Argonaut currently sees large caps in Europe as particularly good value, with many blue chips in areas such as telecoms, pharmaceuticals
and utilities offering dividend yields higher than bond yields.

“Too much money is chasing high-grade corporate bonds and spreads have come in too far, approaching a situation where people trust companies more than governments,” ays Russ.

“If people are willing to take credit risk on bonds, why not go for higher-yielding equities with more potential for capital growth and the added benefit of inflation hedging through a growing dividend.”

On the current debt issue in many European countries, Russ says the euro has altered the situation massively, with a country like Greece no longer simply able to devalue.

But for most companies in afflicted countries, he believes Government issues are largely irrelevant due to globalisation and the proportion of business coming from overseas.

“This is not the case for banks, which need a stable and low bond market to make money, but it is hard to see problems in Spain’s economy
having a huge impact on Telefonica,” adds Russ.

“That said, there will be a fiscal drag in some of these countries as governments try to make up their revenues and tax increases will likely hit
consumer spending.”

Russ’s European income portfolio had a tough 2009, not rotating enough into cyclicals and also struggling as a lower-beta portfolio.

“This is typically not an issue as we make up more than the gap through alpha but if you have a beta of 0.9 and the market rallies 70 per cent – as it did between March and September last year – you are already 7 per cent behind,” he says.

“In general, income stocks did not participate in the rally and a company like France Telecom is trading where it was back in March, offering good value with a 9 per cent yield.”

Russ says individual company accounts are influencing the market once again, which has shifted back to a fundamental focus rather than macro or sector based.

He highlights a recent dividend increase from Zurich Financial, for example, on a day when the overall market was down.

Insurance versus banks is a key theme on the fund, with dividend growth a sign of confidence, according to Russ. “These stocks never had the capital or P&L issues of the banks but were sold down anyway,” he adds.

“Insurers did well in the second half of last year but still have a way to come back after a dire six months, with the bonus of decent dividend growth against negligible distributions from the banks.”

European income remains underweight in banks but while Russ sees earnings as hard to predict, he has identified encouraging trends. “Over recent months, there has been a drop in loan loss provisions but this has not translated into share price performance with all the noise on US banking reform,” he says.

He also notes pharmaceuticals as a strong sector, with the de-rating of solid blue-chips like Roche and Novartis in recent years pushing them into the yield universe for the first time. Looking forward, Russ says the European market is not on demanding valuations as long as earnings come through and looks to be at the start of a cyclical upswing.

“However, this is not a typical cycle because of all the gearing,” he says. “Governments have basically taken public debt into GDP and that
will have to be paid for at some stage. Countries can either grow their GDP or raise taxes to get out of this situation and worryingly, very few are
talking about a growth route out of current problems.”


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