Focusing on six key factors can help investors find attractive companies within Europe, James Sym at River and Mercantile believes.
The manager of the ES R&M European Equity Fund, who has been managing European equity portfolios since 2012, said with so many competing forces in Europe now, investors had to “go against the herd” to find the best opportunities.
“Being underweight Europe has been an easy source of outperformance for the last decade. Most European funds consist overwhelmingly of expensive quality growth stocks – but we offer something very different that will take advantage of this next cycle having different characteristics to the last – which we strongly believe it will,” he said.
To find these opportunities, Sym focuses on six key tenets which he believes can provide an ongoing source of alpha for the fund.
Below, he looks at each in turn along with the names in Europe which are matching those criteria.
Being a contrarian has become increasingly contrarian over the last few years! Nevertheless, it stands to reason over time that the more that people own of the same stocks, the more they must sell when investment fashions change. Equally, crowded areas of the market tend to be overvalued and, in addition, encourage excess capacity as capital flows to these ‘hot’ areas leading to lower future returns.
At the moment our preference for consumer cyclicals such as workwear and hotel linen company Elis would certainly be considered contrarian.
Business cycle investing, with its ‘go anywhere’ mindset, is incredibly pragmatic. It is founded on the insight that different companies do well at different points in the economic cycle. As we move into the economic improvement of 2021, our framework has led us to invest a lot more in recovery stocks such as consumer cyclicals and industrial cyclicals, with significant upside in many cases when they hit pre-pandemic levels of revenue and profitability. Indeed, we have built a fund specifically to benefit from the forthcoming economic upswing which puts us at odds with most funds and their predilection for “special” (but very expensive) companies which have seen significant share price appreciation already during the economically difficult recent years of recession, pandemic and trade wars.
We are expressing our business cycle view of ‘recovery’ through being overweight cyclicals such as the Swiss family fastening business Bossard.
At the risk of sounding old fashioned, I happen to believe the price you pay makes a difference to the returns you get. The growth fetish of the last few years, culminating in a final denouement during the pandemic, makes this an unfashionable view but throughout investment history commentators have written off valuation discipline at their peril…
We believe Catalana Occidente, which we own, is an incredibly cheap asset providing credit insurance. It’s at a low point in its profitability cycle with significant scope for recovery.
Avoiding value traps is the constant goal of the contrarian investor. Allocating capital to structurally challenged businesses is a lesson learnt the hard way. The way to avoid this is to ensure companies have a pathway to more than cover their cost of capital and can deliver some top line growth in the medium term. In other words, look for good franchises temporarily out of favour rather than the deepest value, per se. Or as a battle-scarred veteran once put it to me, “don’t put the valuation cart before the investment horse!”
Dometic has high global market shares in the mobile refrigeration market, fitted in caravans and boats, and makes strong returns on capital. Although not highly rated they also have the opportunity to significantly expand their target markets.
Governance and management
It goes without saying that bad management can ruin a company’s prospects, but in European equities paying attention to governance and shareholder structure is especially important. For example, investing in a well-run family business with a culture of longevity can pay wonderful dividends over time, but avoiding a quasi-state run and owned business whose primary purpose is to provide employment rather than shareholder returns is perhaps equally important.
In our view, the management of the Swedish copper miner Boliden, which we recently added to the fund for the recovery phase is extremely strong, having built the business up over the last 15 years and weathered the various crises in good shape.
Last but by no means least, 2020 will be the year ESG entered the mainstream. While we are nervous of investment fashions, energy transition will no doubt be a preeminent theme of this next cycle and it is perfectly possible to build significant exposure to this theme in a valuation disciplined way. Even more fundamentally, when the negative externalities of a business significantly outweigh its positive contributions over time, governments, regulators or simply their customers are likely to erode that company’s returns and we have seen this again and again – whether the banks from 2008 or oil and gas from 2018. We believe all our investments are contributing positively to society, and that clients can be proud of owning our fund.
A good example of valuation discipline coupled with strong ESG credentials is our holding in NKT, a cable manufacturer with a chequered recent past. However, they have new management and a high exposure to offshore wind farms’ connectivity, so we can access the growth of this market without having to overpay.