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European equities: sorting the wheat from the chaff

European equities: sorting the wheat from the chaff

Managers of European equity funds are certainly spoiled for choice with more than 5,000 companies listed across the region.

Careful stock selection, however, is crucial, a fact acknowledged by Arnaud Cosserat, who is ranked 10th by Citywire Manager Ratio over three years, as shown in the table below.

Despite the vast investment universe at his disposal, the manager of the Comgest Growth Europe fund prefers a concentrated portfolio of 30 positions.

‘We focus on the rare companies that can sustain above average growth in earnings, dividends and cash flow for an extended period,’ he says. ‘They need to have a unique product that gives them a lot of pricing power and be exposed to strong growth trends.’

Of course, this is not always easy. ‘Not many companies are able to sustain double-digit growth in earnings per share,’ he says. ‘Whenever there is growth it attracts a lot of competition and this makes it very difficult to maintain an advantage in the industry.’

Inditex, the Spanish clothing giant behind brands such as Zara, is a good example of the type of company he seeks. ‘It only takes around four weeks from designing a garment to putting it in the shops so this gives it powerful pricing power,’ he says.

Turnover within the fund is also relatively low with only five or six new companies, on average, gaining a place in the line-up each year, while some of the most prominent names have been virtually ever-present in the portfolio. L’Oreal, the cosmetics group, has long been favoured.

‘It has a very broad exposure and serves a market that’s been growing at 4-5% each year,’ says Cosserat. ‘It gets a lot of market share through product innovation and its geographic footprint.’

Tales of the unexpected

Citywire AAA-rated Victoire de Trogoff, manager of the Fidelity European fund, invests in companies where she predicts the future return on capital employed to be greater than the market expects.

‘Stocks are only selected if there is a positive investment rationale and portfolio construction is designed so that stock selection is the key contributor to both risk and return,’ she says. ‘The aim is to deliver little and often outperformance on a consistent basis.’

Top 15 manager in European equities by Manager Ratio over three years

Name Manager Ratio Total Return % EUR Contributing Fund Citywire rating
Dean Tenerelli 1.3 48.81 T Rowe European Equity AAA
Christian Diebitsch 1.17 61.59 Stryx Europa EUR F AAA
Daniel Hemmant 1.16 41.87 PARVEST Equity Europe Growth AAA
Hans-Kristian Sjöholm 1.04 56.83 Evli Eurooppa AAA
Robrecht Wouters 1.03 54.6 JOHCM European Select Values AAA
Victoire de Trogoff 1.02 40.52 Fidelity Europe, Fidelity Funds - European AAA
Franz Weis 1 61.78 Comgest Europe, Comgest Growth Greater Europe Opportunities EuroSpaengler Quality Growth Europe AAA
Matt Siddle 0.96 42.15 Fidelity Funds - European Growth, Fidelity Funds - European Larger Cos, Fidelity Funds - Inst Europ Larger Cos AAA
John Bennett 0.96 43.44 Henderson Gartmore Pan European AAA
Arnaud Cosserat 0.95 59.6 Comgest Growth Europe Euro AAA
Roger Morley 0.94 46.31 MFS Meridian Funds European Core Equity AA
James Rutherford 0.92 53.34 Hermes Sourcecap European Alpha AAA
Clement Maclou 0.86 44.92 CPR Silver Age AAA
Vafa Ahmadi 0.86 38.47 CPR Silver Age AAA
Laurent Dobler 0.86 58.75 Comgest Growth Europe Shariah Euro, Renaissance Europe C, Share Europe-Selection Cap AAA

'Manager Ratio' reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

Over the past year the fund has benefited from positive stock selection in financials, telecom services and industrials. ‘Within financials, banks and insurers were leading contributors,’ she says. ‘UBS has been a particularly strong performer, most recently benefiting from an announcement around the restructuring of its international business and the management’s intention to pay a large dividend.’

Auto stocks such as Continental and Volkswagen have also been justifying their inclusion in recent months.

‘Both stocks have performed well following a good set of results,’ she adds. ‘The auto industry as a whole has seen a recovery in early registrations in Europe. If demand remains at current levels, auto production could rebound in the second half of this year.’

Shrewd strategies such as this have earned her a Manager Ratio of 1.02, which places her sixth in the rankings over three years. Elsewhere, she is finding good opportunities in the materials, information technology and healthcare sectors with pharmaceuticals firm Sanofi seen as a key holding.

‘The stock is attractively valued and is expected to gain from a focus on diabetes and exposure to the emerging markets,’ she says. ‘Bayer is another large position as it has good growth prospects in both the pharmaceuticals and crop science businesses.’

Going for growth

A-rated Alexander Darwall (pictured left), who ranks ninth over five years by Manager Ratio as shown in the table attributes the success of his Jupiter European Growth fund to a policy of targeting structural growth, rather than cyclical, and says this stance has helped insulate it from the slowdown in global growth.

On a similar tack to de Trogoff he suggests the rise in Type 2 diabetes is a prime example of the opportunities available in the marketplace.

‘It has meant a company like Novo Nordisk, which specialises in insulin analogues, can continue to grow its top line at double digit rates in virtually all its markets as a greater number of people adopt western dietary habits,’ he says.

Other positive contributors to fund performance have come from companies that all share certain characteristics, even though they are involved in different business activities. These include Reed Elsevier (publisher), Experian (provider of global information services), Wirecard (electronic payments processor), and Amadeus IT (transaction processor for global travel and tourism).

‘All these companies have strong underlying business models,’ he says. ‘They are involved in a structural growth trend, are not captive to governments/regulators, have business models that travel well, an abundance of intellectual property, and don’t carry too much debt.’

A good example of his favoured picks is Edenred, a French company that operates in the overlooked and fragmented area of pre-paid employee vouchers.

‘It provides companies with ways to increase employee benefits without them having to pay social security contributions or payroll tax, thus reducing costs,’ he says. ‘Edenred charges companies a fee on voucher issuance but only reimburses merchants some two months afterwards, creating a float that can generate further financial revenues.’

Exposure to global trends

AAA-rated John Bennett, director of European Equities at Henderson Global Investors, who holds a Manager Ratio of 0.96 over three years, placing him ninth, sees himself as managing a fund of global businesses rather than being the manager of a European fund.

‘It may sound glib, but it’s a serious point,’ he insists. ‘The great mistake being made is thinking the European stock market is the European economy.’

The reality is that many of Europe’s largest companies generate a high percentage of their revenues outside the region. ‘We have some of the most global businesses you can find and the great thing about Europe is you can access the same world as other markets but at a discount because the region has been masked by all these macro issues.’

Even a cursory glance at Bennett’s Henderson Gartmore Pan European fund illustrates the point with the 10 largest holdings including international household names such as Novartis, Roche, GlaxoSmithKline, Bayer, HSBC and Reed Elsevier.

Again, these picks also reflect global themes highlighted by other fund managers such as drugs and health care. ‘We believe that the pharmaceuticals industry in Europe is perhaps two or three years into a decade-long renaissance, with good long-term prospects for revenue growth from sustainable sources,’ says Bennett.

Consolidation cements value

While stock selection is significantly more important to Daniel Hemmant of BNP Paribas than macro bets, he suggests that the deciding factor as to whether or not a position is successful largely depends on the industry structure.

Top 15 manager in European equities by Manager Ratio over five years

Name Manager Ratio Total Return % EUR Contributing Fund Citywire rating
Julian Gould 1.08 64.65 IVI European AA
Adriaan de mol van Otterloo 1.08 64.65 IVI European AA
Roger Morley 1.07 60.39 MFS Meridian Funds European Core Equity AA
Frédéric Plisson 0.99 71.82 Echiquier Major A
Pierre Duval 0.79 42.53 Conservateur Unisic A
Kenneth Blomqvist 0.79 78.72 Fondita European Top Picks A
Olgerd Eichler 0.73 65.74 MainFirst - Top European Ideas A
Torsten Graf 0.73 65.74 MainFirst - Top European Ideas A
Alexander Darwall 0.73 66.05 Jupiter JGF European Growth A
Daniel Hemmant 0.71 43.04 PARVEST Equity Europe Growth AAA
Franz Weis 0.70 77.96 Comgest Europe, Comgest Growth Greater Europe Opportunities EuroSpaengler Quality Growth Europe AAA
Roderick Jack 0.68 55.72 Adelphi European Select Equity AA
Marcel Jongen 0.68 55.72 Adelphi European Select Equity AA
Anas Chakra 0.67 52.50 Fidelity FAST Europe A
Nigel Bolton 0.67 36.68 BGF European A2 EUR, BGF European Focus, Multi Manager Invest Europa, Multi Manager Invest Europa Akkumulerende A

'Manager Ratio' reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

The AAA-rated manager of the Parvest Equity Europe Growth fund argues that firms operating in sectors with a relatively low number of players often benefit from not only superior profitability but also less risk to their earnings streams.

‘We really like to see consolidation – whether this is due to M&A with the biggest companies expanding or when you are at the bottom of the cycle and a bunch of firms are being forced out of the industry,’ he says. ‘The industry structure is the key determinant of a company’s ability to grow its profitability in a sustainable way.’

He cites the example of the tobacco industry, pointing out that the lack of growth in the sector has been significantly outweighed by the benefits of the massive consolidation that has resulted in the few companies left having clear pricing power. ‘There’s a similar dynamic going on within beer as the big brewers are steadily buying up a lot of the smaller players,’ he says.

‘This means you have a cost reduction story in more developed markets where you’re unlikely to get much growth.’ Over the last five years the performance of the fund has been driven as much by side-stepping potential banana skins as it has by exposure to the right areas.

‘It’s been about avoiding the stocks that do badly,’ he says and this strategy has helped place him third and 10th over three and five years respectively by Manager Ratio.

Nuggets of value

Finding a niche within a larger sector can also be the key to success, says Dean Tenerelli, AAA-rated manager of the T Rowe European Equity fund, who describes his portfolio as being an ‘eclectic collection’ of different businesses.

One of his most significant holdings is in the Restaurant Group, which operates more than 400 restaurants and pub restaurants. Many of these are household names such as Frankie & Benny’s, Chiquito, Coast to Coast and Garfunkel’s. Although there’s no shortage of eating establishments, the company’s differentiating factor is the way it runs its business.

‘Restaurants are located in retail parks and sites outside of town centres that have little competition but a lot of footfall,’ he explains. Alongside a team of 20 analysts, Tenerelli runs his own screens to reveal why a particular company has been able to deliver high returns over time.

To do so he uses a very strict free cash flow valuation that cuts off growth after the foreseeable future.

‘I don’t pay a lot for the promise of growth in perpetuity so my businesses tend to be very down to earth companies that are generating cash flow today rather than a single product company that may have a hit product in five years’ time,’ he says.

On a country perspective, Tenerelli believes Spain offers the best opportunities, which is why it accounts for 14% of his fund. ‘It has liberalised its labour market, dealt in part with its pension issues, and you can see an improvement in productivity.’

The recent uplift in economic data aside, managers of European funds appear extremely confident that strong companies with solid growth prospects can be found across a wide variety of sectors and geographies. At the end of the day Europe is extremely interesting, says Tenerelli, who comes in top of the three-year table by Manager Ratio.

‘Last year was a once-in-a-lifetime opportunity to buy great companies at bargain prices,’ he says. ‘Now you can still buy great companies at reasonable prices – and cheaper than other markets.’

This article originally appeared in a supplement accompanying the September 2013 issue of Citywire Global magazine

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