June 2012


LighthouseThings are changing fast in Europe, and some investors are afraid of what this may bring. Fiona Rintoul finds out what equities managers can do to allay fears. Six months ago, a Greek exit from the euro was unconscionable and austerity dominated the political agenda in Europe. Now, a Greek exit looks likely. And since France dumped Nicolas Sarkozy for the socialist François Hollande, growth has been the buzzword. Things are changing fast in Europe and no one knows where the next turn will take us. For European equities managers, this means their job has changed, too. Managers such as Alice Gaskell, who co-runs the BlackRock Continental European Income fund, are dusting off their politics degrees, hitherto unused since university. Today’s European equities manager needs to understand the whole financial system, not just the equity markets, as well as the politicians whose decisions – more than ever – are driving that system. “We have spent a lot of time talking to political lobbyists and politicians,” says Gaskell. But if it is important to understand the political background in Europe, it is equally important to be able to tune out the political noise to catch the corporate beat beneath. The Greek situation is causing uncertainty, and investors do not like uncertainty, but it may also create opportunities. “Buy when blood is running in the streets,” says Mark Glazener, head of global equities at Robeco. “If Greece leaves the euro, that creates turmoil. We would see that as a buying opportunity rather than a reason to sell.” Valuations
European equities have become the unloved asset class, with Asian and US investors, in particular, running scared of the ongoing uncertainty in the eurozone. But now that markets have punished European companies for the economic frailty that surrounds them, many fund managers see bright spots in the gloom. “There is a fundamental reason equities in Europe are attractive: valuation,” says Daniel Pasini, global equities portfolio manager, at ACPI Investment Managers. “Stocks in Europe are cheap on a price-to-book, price-to-earnings and price-to-sales basis. However, stocks in Europe are not trading on the back of valuations or earnings, but fear.” Fear makes people do stupid things, such as ignore company fundamentals and the short-term opportunities that volatility can bring. Fabio Di Giansante, senior portfolio manager for Euroland equity at Pioneer Investments, tries to capitalise on those short-term opportunities, while at the same time pursuing business as usual. “We don’t see why we should change our approach,” he says. “We don’t know what the politicians will do but we do know that domestic GDP growth won’t be fantastic in Europe. We therefore want to be exposed to global themes.” For Di Giansante that means seeking out companies that do good business in emerging markets and the United States. Increasingly, this leads him to consumer rather than industrial names. In China, in particular, western industrial companies no longer enjoy the advantage they once did because indigenous companies have caught up in terms of quality, and the Chinese government favours them over foreign firms. “On the consumer side, the [quality] advantage is still there,” says Di Giansante. “It’s related to brand, especially luxury brands. The first thing people in China do in terms of spending is buy Western brands – not just Louis Vuitton but also food brands, such as Danone and Unilever and personal care items, such as shampoo.” Others play this global exposure theme a little differently. Philippe Brugere-Trelat, portfolio manager at Franklin Templeton for the Franklin Mutual European fund, thinks the China and Asian story is “a little long in the tooth” and looks instead for companies with exposure to Latin America and North America. “We find a lot of value in Germany,” says Brugere-Trelat. “There is an impresseive number of large and not so large industrial companies with a great global footprint.” Not so large is another interesting theme for some European equity managers. Small-cap stocks should outperform large-cap stocks in Europe, says Thierry Cuypers, head of small and mid-cap equities management Europe at Natixis Asset Management (NAM). And, importantly in the current climate, small-caps should resist well if there is a big sell-off in the market. “Small-cap stocks are not played by hedge funds, so they are a little protected from speculative sales,” he says. In a corporate landscape littered with examples of large global firms that have screwed up – the most recent being JP Morgan – small companies potentially offer another advantage: very often they are better run than larger companies, says Cuypers. “Even if they aren’t, it’s easier to spot. We understand better what they are doing.”  Whether European equity managers operate in the small to mid-cap universe or the large-cap universe, and whatever theme they pursue, there can be little doubt that this is a stock-picker’s market. Cuypers’s colleague, Olivier Lefèvre, senior equity portfolio manager at NAM, may well be right when he says that, “valuations in Europe are at the bottom or near the bottom and we can’t imagine another earnings downgrade”. But there are too many political and economic uncertainties for anyone to expect across-the-board rises on European stock markets.   “You need to be quite selective,” says Lefèvre. There’s really no avoiding geography either, whatever investment approach is taken. “As stock-pickers, we’ve been compelled to incorporate macro considerations more than before,” says Brugere-Trelat. Thus he has withdrawn from Spain and Italy, even though there are some companies that seem to offer good value at the moment. Being cheap is not enough. For a risk-averse investor such as Brugere-Trelat, companies need to be cheap for the wrong reasons. “There’s a very high level of risk involved in being in those Italian names because of macro considerations,” he says. “We want to be in big companies that are very open to the rest of the world and are unjustifiably marked down by investors because they are domiciled in Europe.” Bunga-bunga
In broad terms, European equity managers are agreed on geography. It is a case of run away screaming from Portugal, Greece and Spain and cherry-pick opportunities in Northern Europe, particularly non-eurozone countries, such as the UK, Switzerland and certain Nordic countries. The main area of disagreement is Italy. For some, economic mismanagement and bunga-bunga parties have created a cocktail too poisonous to try. Others, however, are prepared to have a sip.  ”It’s down to stock-picking,” says Lefèvre.  “We have strong positions in stocks that have considerable exposure to emerging markets and make more than 50% of their sales outside Europe.” Gaskell, meanwhile, suggests that Italy’s problems are much smaller than those of the other southern European countries. “The government is committed to pulling itself out of this crisis,” she says. “By next year, Italy will be one of the countries with the lowest fiscal imbalance. Italian companies are trading at their lowest valuations since 1975.” Sell-off
And even southern Europe could get interesting if there is a sell-off. “Our strategy at the moment is to favour strong companies that benefit from growth outside Europe,” adds Gaskell. “But if there is a sell-off, we will look again at the domestic options in the universe and we will look into southern Europe again. Currently, Spain, for example, still doesn’t look very cheap.” Everything is up for grabs in Europe, and it is hard, if not impossible, to have a fixed strategy. There are various ways to deal with that. You have to be dynamic and flexible, says Di Giansante. You have to be patient, risk-averse and very diversified, says Brugere-Trelat. You probably have to be all of those things. And you have to second-guess politicians – to say nothing of their electorates. That volatility is not going to go away any time soon, but it is the reality that a lot of European companies are in good shape. “If you set European companies in an international context, their strategy and product mix are as good as those of US companies,” says Glazener. “If you take the example of consumer staples, including those in the UK, their strategy in emerging markets is much better than what you would find in the US.” ©2012 funds europe

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