Foundation Fundlist European sector review

A look at three funds offering exposure to European shares and their performance over the past year.

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  1. Rob Morgan

Factories and offices across the world are closed and streets are quiet as measures to counter the spread of Covid-19 continue. In Europe, business activity has fallen to record lows, with steep declines in manufacturing and services. Impact varies from country to country with Italy, Spain, France and Germany so far coming under the most pressure. Some of the Nordic countries have fared better, and in Sweden’s case full lockdown has been avoided so far, though things can change quickly.

The virus shutdowns compound some of the issues already affecting Europe. The German car industry and broader economy have already endured a slowdown and now it faces considerable supply-chain issues and a collapse in demand that may not fully return for some time. In addition, the looming threat of President Trump declaring a EU phase of his trade war, targeting EU tariffs on food and cars, hasn’t gone away.

Europe could also face a more fractious political climate. Despite the European Central Bank relaxing its approach to budget deficits and expanding its Quantitative Easing programme to flood the financial system with more money, badly affected countries like Italy, Spain and Greece already had high levels of debt and their position has deteriorated. There are growing tensions over the extent to which the eurozone as a whole should stand behind the growing debts of its weakest members.

Despite these issues, Europe offers some opportunities for investors. Whether you’re seeking exposure to leading brands and innovators in their fields, wanting to diversify a dividend stream away from UK equities or aiming to take advantage of depressed valuations, European shares are likely to offer some interesting options. There’s a diverse range of options and some world-leading businesses in areas such as industrials, healthcare and luxury goods.

With such a breadth of companies, Europe is also a clear example of how the market is increasingly split between the loved and the unloved in terms of share price performance; businesses that are perceived to be structurally challenged have been shunned, perhaps wrongly in some cases, while those with cashflows perceived to be long in duration and high in quality have found increasing favour with investors.

A number of successful stock pickers operate in the area for investors looking to find the best opportunities and maximise long term returns from the region. Below I take a look at the characteristics and recent performance of the three actively-managed European funds on our Foundation Fundlist following our recent annual review of the sector.

BlackRock European Dynamic

Manager, Alister Hibbert, has a flexible, concentrated approach and attempts to capture opportunities across a wide range of European companies. He has demonstrated an ability to generate strong performance relative to his benchmark and peers across a range of different market conditions since he started running the fund in 2008. While past performance is not a guide to future returns, we believe this is potentially one of the best means of accessing European markets for investors targeting capital growth and willing to hold for the long term.

Hibbert sits within a team that we regard to be one of the most capable and well-resourced in the sector. He is focused on finding companies trading on reasonable valuations relative to history, but which also have growing earnings. Although the fund should be expected to be predominantly invested in larger companies he is also happy to venture down the size spectrum if he sees the right opportunity.

As the name suggests the portfolio is dynamically managed and this is reflected in the higher-than-average turnover. The same is true of the fund’s style, though given the significant size of the fund, it is concentrated in larger companies, and especially those that are a bit more expensive than the average but offer good growth prospects. It remains our favoured holding for ‘core’ exposure to European shares.

The fund has enjoyed a strong year, outperforming the average fund in the sector and adding to its impressive long term record across a range of market conditions. Exposure to technology through semiconductor company ASML and enterprise software giant SAP has proved resilient recently, while healthcare stocks NovoNordisk and Lonza Group have also bounced back strongly from lows in March. Meanwhile, top holding LVMH has experienced a particularly volatile share price this year as the outlook for the luxury goods appears highly uncertain.

BlackRock Continental European Income

This fund targets a reliable and growing income stream from Europe’s larger companies. The team do not fixate on achieving the highest current yield possible; instead they seek a sustainable distribution that will grow over time and support capital growth. The quality bias and premium dividend has historically resulted in resilience in more difficult markets and there are few firms that can match the level of resource BlackRock dedicate to European equity research.

The fund has around half of the portfolio invested in above-average yield stocks in areas such as insurance, infrastructure, telecoms and utilities. The rest is in what the managers call ‘steady eddies’ (more highly prized, reliable stocks with lower yields) and dividend ‘growers’, companies which have smaller yields but are expected to grow their pay outs more rapidly. By blending these types of stocks together they aim to deliver a sustainable income that will grow over the longer term and support capital growth – rather than just a very high starting yield.

A slowdown is the type of environment that should suit this fund (in a relative sense versus the broader market) given the managers’ emphasis on cashflow and dividend sustainability. Having no exposure to banks has also been a big help, though there is plenty of broader financials exposure through insurers and various diversified companies. Another positive has been the absence of oil & gas shares. Having accounted for 4% of the portfolio in December 2019, these were completely cut by February.

The manager also cut risk more broadly from December, leaving some room to add it back selectively during the market selloff. A position in luxury goods producer Kering was initiated on weakness and a relatively new position in Volvo was built further. Meanwhile, Telia, the Finnish telecommunications firm, was an underperformer sold at the end of last year. Reliable utility networks and renewables capital expenditure continues to be a theme. For instance, top-five holding Enel, an Italian electricity and gas distributor, is going through a process of decarbonisation and is developing further power generation from renewables.

Although it is rather too early to make performance assessments about how various funds have handled the Covid-19 triggered economic paralysis, thus far the fund is behaving as we’d hope and has held up better than the broader market. Some dividend cuts or suspensions are inevitable among portfolio constituents and this will likely have an impact on income pay outs from the fund. However, we anticipate this should be mitigated by the diversified nature of the portfolio and the relatively defensive characteristics of many of the holdings.

FP Crux European Special Situations

Managers Richard Pease and James Milne invest for the long-term and tend to stand by their convictions, trading holdings in the portfolio only infrequently.  They are also very particular about the sorts of companies they invest in, often favouring family-owned businesses that can expand globally in niche areas without the need for external finance. They like to see healthy, repeatable cash flow from secure revenue streams and robust balance sheets.

We believe the managers have an excellent knowledge of the European market that allows them to uncover growth opportunities that others may overlook. We also admire their patient approach that allows businesses time to deliver on their growth potential. They invest in a high-conviction manner and search across the entire market regardless of size, including smaller companies with greater growth potential but higher risk. A relatively concentrated portfolio of around 60 holdings adds to the level of risk and means each stock idea can make a significant impact on performance.

The fund performed reasonably well in 2019, marginally ahead of the broader market. Many of its medium-sized companies performed well following a difficult period at the end of 2018, including Spie, Smurfit Kappa and Bravida. The fund also benefitted from takeover bids for Ramirent and Cramo at significant premiums to the prevailing market price. Successes among larger companies included Schneider, Kuehne & Nagel, Kone and Deutsche Boerse.

Pease is one of the more experienced managers in the sector and notes the extraordinary speed of the Covid-19 induced selloff, comparing it to that of 1987. When we spoke to him in the midst of the declines, he remarked on some of the “crazy” valuations and said European equities could get an “almighty bounce” on better news.

During the sell-off the fund’s bias towards ‘capital light’ businesses (where a company has relatively few capital assets compared to the size of its operations) and relatively low debt levels was beneficial. A very small position in oil services and no direct aviation exposure was also helpful, albeit the managers have now added Airbus on weakness. Overall, the fund's bias to small and medium-sized companies detracted. Having dialled back exposure to some of the holdings that have held up better than others, there is a little more cash held than usual.  

Table: First quarter 2020 and discrete annual performance of the above funds, peer group sector and benchmark

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, 2020 YTD data: 31/12/2019 to 31/03/2020

 

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