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Sector focus: Quality European companies will weather the storms

Funds invested in Europe have stayed among the most consistent in recent years.

James Smith FS 160 byline

While Europe remains at risk from a macro standpoint, funds investing in the region have proved among the most consistent in the market over recent years.

As expected given the turbulent background, most of this success has come from ignoring economic noise as far as possible and focusing on picking companies – and Europe boasts many world-leading businesses across a range of sectors.

Of course, no one can picks stocks in a vacuum and anyone considering Europe has to take the macro environment into account.

Despite the stabilising influence of the ECB’s outright monetary transactions – which removed the immediate risk of eurozone break-up – many of the periphery countries remains in recession and core growth is only strong in this context.

Macro turmoil has driven down valuations in the equity side and many investment managers continue to cite current levels as a good entry point to the market.

Anyone prescient enough to move back into European equities last year was well rewarded. The European Smaller Companies fund sector was the best performer over 2012 returing almost 23 per cent, with Europe ex-UK in third place.

Looking over one, three and five years to mid-March, several funds are among the top performers over all three periods, highlighting the number of consistent franchises in this peer group.

Threadneedle European Select features in the top three over three and five years, for example, broadly correlating to manager Dave Dudding’s tenure on the portfolio.

While he does not expect Europe’s economies to perform well for several years, he sees a raft of positives for globally focused firms in the region.

Dudding says: “Many European economies are mature, governments are following austerity policies, banks are deleveraging and demographics are not great. But good-quality European corporates are finding it easier than ever to raise money at low rates, creating a golden opportunity for well-capitalised multinationals.”

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With years before Europe’s global competitiveness returns, the manager says investors must focus on companies growing their exposure to emerging markets.

He cites long-term European Select holding Nestle as an example, with the company able to continue boosting returns through market-leading positioning in China as well as Brazil.

Other themes in the portfolio are Europe’s ageing population, evident through an overweight healthcare position in stocks such as German dialysis company Fresenius.

Elsewhere, BlackRock has also found success in the region running several funds with a core stockpicking strategy, with European Dynamic and Continental European both top quartile over one, three and five years.

More recently, the underweight position in financials, which have rallied strongly, has been something of a drag.

Taking the more aggressive Dynamic fund first, manager Alister Hibbert highlights recent positive stock selection in consumer services and technology as well as beneficial underweights in telecoms and utilities.

Stressing the overseas exposure theme once again, he flags up luxury goods company Richemont, owner of brands such as Cartier and Van Cleef & Arpels, as the best-performing position during the fourth quarter.

He says: “The improvement in Chinese macro data is key for Richemont, which makes over 25 per cent of its sales in China and Hong Kong.”

While a large amount of money has flowed into Europe since last year, he notes there is still scope for allocations to double before reaching long-term average allocations.

Blackrock Continental European manger Vincent Devlin has the same basic process with a few more constraints in place.

This typically means taking less aggressive sector and country positions against the benchmark and smaller stock weightings.

Again, overweight positions include industrials and consumer discretionary, with financials a consistent underweight, along with utilities and telecoms.

Devlin says: “While [ECB president] Mario Draghi’s OMT policy has improved the situation and alleviated some pressure on banks, we are still some way from seeing them as investable.”

Focusing on some of his key stock picks over recent years, Devlin flags up Amadeus as well as Finnish lift company Kone.
On the former, he says this transaction processor for the global travel and tourism industry is a strong example of a European company with market-leading products on a global scale.

Jupiter’s Alexander Darwall is yet another long-term performer with his European fund, again focusing on finding the continent’s world-class companies.

His approach looks to identify so-called special companies, with Darwall highlighting business model, management team, underlying structural story and valuation as key factors to earning this status.
He says: “At the core, we are seeking stocks offering defensive and offensive characteristics. The former requires a resilient business model and factors such as profitability and high barriers to entry and the latter means something on top of this, like potential new markets to access.”

During his decade-plus on the Jupiter European fund, Darwall has kept to this business model focus rather than trying to time moves in and out of sectors.

While avoiding macro calls in general, Darwall’s fund does have a bias towards stocks with substantial presence outside of Europe.

Darwall says: “Early on, we took the view that it was possible to find solid growth outside the developed world and many holdings derive a good portion of earnings from overseas, primarily the US and emerging markets.”

Darwall’s process is typically low turnover and half the positions in the portfolio have not been sold, although he has altered weightings, since the end of 2005.

Looking over shorter timeframes, Henderson European Special Situations has quickly established itself as a top performer since launch in 2009.

Manager Richard Pease said the portfolio has largely outperformed due to overweight exposure to industrials and basic materials, again lagging shorter-term as holdings struggled to keep up with fast-rallying banks, particularly in Southern Europe.

Like many of his peers, Pease highlights lift maker Kone, as well as several industrial holdings with more cyclical or construction-related exposure.

Pease says: “Although the second half of 2012 demonstrated greater determination from European politicians to hold the euro together, we think coming months could be bumpier. Apart from potential for political impasse in Italy after the election and challenges posed by the latest corruption scandal in Spain, attention will return at some stage to debt in many countries and the difficulty of reducing it at likely growth rates.

“Rather than hoping for political decisions to address structural issues, our portfolio is composed of companies that should prosper even in tough times thanks to exposure to faster-growing economic areas and robust pricing power.”

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