Over the past year, and particularly during last summer, I mentioned on a number of occasions that European stockmarkets looked good value on many measures.
Our own analysis suggested stockmarkets looked significantly cheaper than their long-term average. While this alone can’t be considered a definite buy signal, it can suggest much of the downside is already priced in. A year later and the European stockmarket, as measured by the FTSE AW Europe ex UK Index, has risen 26 per cent with dividends reinvested.
Despite this some funds have not performed as well as I would have expected. One such fund is Schroder European Alpha Plus, which has returned a decent 24 per cent but still lagged the wider stockmarket.
The fund is managed with a focus on quality businesses with strong growth potential. Around a core of businesses that fit the bill from this perspective though are a number of companies more sensitive to economic growth; those which have underperformed or become unloved; and those going through a restructuring.
On a recent call, Leon Howard-Spink, the fund’s manager, confessed his performance had not been good enough. The top four companies which contributed negatively to performance cost him 3.5 per cent over the period. They have all now been sold.
He concedes these were stock specific mistakes and the bulk of the losses came at the end of 2012. Three of the stocks (Saipem, Fugro, and Vopal) suffered from profit warnings related to the energy market. The latter two had been successful long-term holdings so all was not lost, but it remains a disappointment. The fund now has no exposure to either the major oil companies or oil service companies.
As well as stock specific mistakes Howard-Spink says his style of focusing on quality companies with growth potential has been out of favour. Unloved value companies with recovery potential have tended to perform better and he tends to hold less in these stocks.
Instead, he has focused on companies with high cash flow, high return on equity, and lower debt, but which still look good value. Surprisingly, companies with these characteristic have not performed as well over the short term.
In general, quality companies with global growth potential have become more expensive and Howard-Spink has made some adjustments to the portfolio to reflect this.
He has added names he held in the past such as Syngenta as its valuations moved to more attractive levels. He is also keen to get new ideas into the fund and wants the top three contributors over time to be an eclectic mix of companies, not just household names.
He has also increased exposure to higher-risk smaller and medium-sized companies, adding GEA Group, for example. This is a German manufacturer of food processing equipment. It sells a lot to the emerging markets and Howard-Spink believes earnings should continue to rise and the valuation is reasonable. Let’s hope the recent troubles in emerging markets don’t affect this type of company to a great degree.
The top three contributors to performance over the past year have all been banks: BNP, DNB and UBS. He has tended to be underweight banks for his whole career, but as a stockpicker is willing to use his flexibility to seek opportunities in a variety of sectors.
He wants to maintain a diversified portfolio which might provide some relative shelter from a tough economic environment, but equally could perform well in a recovery. That said, he is keen not to over diversify the portfolio and wants each stock to contribute to performance so has reduced the total number of holdings to 38 companies.
European stock markets are like most others, driven by news flow, much of which tends to be from the US Federal Reserve or the European Central Bank. As yet Howard-Spink has seen no earnings upgrades, suggesting companies are not yet seeing a recovery in Europe. He still believes stockmarkets are cheap though and describes himself as cautiously optimistic.
We could see more stock market volatility over the coming weeks. Elections in Germany, and the decision by the US Federal Reserve over the extent to which it will taper its bond purchases, are likely to contribute.
Howard-Spink has a long and successful track record though and his recent underperformance can be partly explained by his style being out of favour. I would be tempted to use any further weakness as a chance to top up as I would expect long-term investors to be rewarded.
Mark Dampier is head of research at Hargreaves Lansdown