Europe’s Lazarus-like re­cov­ery this year leaves fund port­fo­lio man­agers still cau­tious.

Af­ter years of strug­gling with slug­gish growth and high un­em­ploy­ment, Europe is on the mend. The out­look for po­lit­i­cal sta­bil­ity is also im­prov­ing, de­spite Brexit

Investment Executive - - FRONT PAGE - BY MICHAEL RY VAL

europe has staged a lazarus- like re­cov­ery this year af­ter a mis­er­able 2016, thanks in part to more favourable macro­eco­nomics and pol­i­tics. How­ever, fund man­agers are also cau­tious, given strongly ris­ing mul­ti­ples.

“The earn­ings re­cov­ery in the U.S., post-fi­nan­cial cri­sis, was stel­lar and earn­ings were much higher than the pre­vi­ous peak. But Europe came later. Earn­ings tracked side­ways for a while and have been catch­ing up in the past 18 months,” says David Lam­bert, se­nior port­fo­lio man­ager with Lon­don, U.K.-based RBC Global As­set Man­age­ment (U.K.) Ltd. (RBCGAM/U.K.), who co­man­ages RBC Euro­pean Equity Fund with Do­minic Walling­ton, RBCGAM/U.K.’s chief in­vest­ment of­fi­cer. “A weaker euro did help ex­porters, but gen­er­ally there’s been top-line growth. And [gross do­mes­tic prod­uct] num­bers have been pick­ing up.”

The Euro­pean Union (EU), as a whole, is ex­pected to ex­pe­ri­ence eco­nomic growth of about 2.2% in 2017, says Lam­bert. Gross do­mes­tic prod­uct (GDP) for Spain, for ex­am­ple, is ex­pected to grow by 3.2% this year.

“[The EU is] com­ing off a low base, but [these coun­tries] have fixed a lot of prob­lems. Next year’s GDP fore­cast in Spain is 2.7%. GDP num­bers [in the EU] have been rel­a­tively ro­bust,” says Lam­bert, not­ing that un­em­ploy­ment dropped to 3.7% in Ger­many, to 4.4% in the U.K. and to 9.8% in France. “Things are mov­ing in the right di­rec­tion.”

From a po­lit­i­cal per­spec­tive, Lam­bert says, the en­vi­ron­ment has calmed down con­sid­er­ably, and he cites re­cent elec­tion re­sults.

“The po­lit­i­cal risks seem to have moved away from Europe and to­ward North Amer­ica,” says Lam­bert. “The risk of an [EU] breakup is a lot lower and it would be sur­pris­ing if we got any­thing un­usual in Ger­many. Brexit is the one known un­known, and it’s a bit too early to say how it will shake out.” He notes that the hard­lin­ers in the U.K. ap­par­ently are giv­ing in to those in the “soft” Brexit camp.

From a val­u­a­tion stand­point, Lam­bert ad­mits, he’s con­cerned that the bull mar­ket is long in the tooth and that mul­ti­ples have risen ap­pre­cia­bly: “We need to see earn­ings con­tinue to come through. We need the earn­ings to do the heavy lift­ing. That’s what keeps me up at night.”

Lam­bert is a bot­tom-up in­vestor, and the RBC fund’s coun­try weight­ings are a byprod­uct of stock se­lec­tion. The U.K. ac­counts for 28.3% of the fund’s as­sets un­der man­age­ment (AUM); Ger­many, for 12.9%; the Nether­lands, 12%; and Switzer­land, 9%; with smaller weight­ings in coun­tries such as Den­mark. From a sec­toral per­spec­tive, fi­nan­cials ac­count for 19% of AUM, fol­lowed by con- sumer staples (16.3%), in­dus­tri­als (15%) and health care (12.4%), with smaller hold­ings in sec­tors such as en­ergy.

A top hold­ing in the 50-name RBC fund is Ryanair Hold­ings PLC, par­ent of a lead­ing, low-cost air­line based in Ire­land. “It’s the high­est re­turn-on-cap­i­tal air­line in the world,” says Lam­bert, adding that the stock’s cash flow re­turn on in­vest­ment is 14.4%. Ryanair, by be­ing the low­est-cost provider and serv­ing about 125 mil­lion pas­sen­gers a year, has been able to get bet­ter terms with air­ports and boost its par­ent’s re­turns. Shares are trad­ing at 17.70 eu­ros ($24.90), or 15.5 times for­ward earn­ings. There’s no stated target, al­though Lam­bert be­lieves that Ryanair can com­pound its share­hold­ers’ equity by double dig­its. theeu­ro­pean­cen­tral­bank has con­tin­ued to be ac­com­mo­dat­ing and un­em­ploy­ment rates also have im­proved, ob­serves Matt Pe­den, vice pres­i­dent and port- fo­lio man­ager on the global eq­ui­ties team of Atlanta-based In­vesco Ad­vis­ers Inc., who is lead man­ager of Tri­mark Euro­plus Fund. But, he adds, mar­kets have been helped by the re­moval of sev­eral key head­winds, such as un­cer­tainty re­gard­ing France’s elec­tions and Italy’s bank­ing cri­sis.

“[Em­manuel] Macron, the proEU can­di­date, had quite a strong ma­jor­ity win and there­fore, France will re­main in the EU and push for more in­te­gra­tion,” says Pe­den, who shares du­ties with Michael Hatcher, vice pres­i­dent, global eq­ui­ties, at Toronto-based Tri­mark In­vest­ments Ltd. “There’s hope that Macron will i mple­ment some re­forms and boost the econ­omy.”

Mean­while, Italy’s bank­ing sys­tem had long been plagued by a large stock of non-per­form­ing loans and sev­eral banks were ex­pe­ri­enc­ing large with­drawals of de­posits.

“The turn­ing point was prob­a­bly in June, when the gov­ern­ment bailed out two regional banks with a 17 bil­lion euro fund and acted as a back­stop to their non-per­form­ing loan book,” Pe­den says. “We had a res­o­lu­tion of some of the lingering con­cerns peo­ple had about Europe.”

In­vestor sen­ti­ment has swung back to Europe, says Pe­den: “From what I’ve heard, peo­ple are see­ing rel­a­tively bet­ter value in Europe af­ter the strong per­for­mance of the U.S. mar­ket. The is­sues around the bank­ing sys­tem are start­ing to fade away, pro­vid­ing in­vestors with more con­fi­dence.”

Nev­er­the­less, Pe­den ar­gues that val­u­a­tions are ex­ces­sive: “We are at the up­per end of the range. Most global in­dices, with the ex­cep­tion of the emerg­ing mar­kets in­dex, are near­ing his­toric highs.” The bench­mark MSCI Europe in­dex is trad­ing at 20.3 times trail­ing earn­ings and 14.7 times for­ward earn­ings, while the S&P 500 com­pos­ite in­dex in the U.S. is trad­ing at 23.6 times trail­ing earn­ings and 18 times for­ward earn­ings.

How­ever, Pe­den ad­mits he’s be­ing cau­tious, based purely on eq­ui­ties val­u­a­tions. As a re­sult, about 20% of AUM is held in cash.

“We sold a few hold­ings, which reached full val­u­a­tions and there was some down­side risk,” he says. “Given where the mar­ket is and the val­u­a­tions on the type of qual­ity busi­nesses that we look for, we have not been able to re­place those hold­ings. This cash level is con­sis­tent with last year.”

Pe­den, a bot­tom-up in­vestor, has al­lo­cated about 40% of the Tri­mark fund’s AUM to the U.K., al­though many of those firms gen­er­ate most of their rev­enue out­side the U.K., such as Di­a­geo PLC and Reckitt Benckiser Group PLC. There’s also 12.9% of AUM in France, 5% in Den­mark and 4% in the Nether­lands, with smaller hold­ings in coun­tries such as Ire­land. The sec­tor al­lo­ca­tion is dom­i­nated by 39.3% in in­dus­tri­als, fol­lowed by 23.1% in con­sumer staples and 5.7% in in­for­ma­tion tech­nol­ogy, with smaller hold­ings in sec­tors such as fi­nan­cials.

One top hold­ing in the 22name Tri­mark fund is Unilever NV, the Nether­lands-based global con­sumer staples con­glom­er­ate that fought off a takeover bid last win­ter from Chicago-based Kraft Heinz Co. “[The takeover bid] put pres­sure on Unilever’s man­age­ment team to run the busi­ness more ef­fi­ciently. Share­holder re­turns seemed to be sec­ondary to ESG ini­tia­tives that were pushed by its CEO, Paul Pol­man,” says Pe­den. (ESG stands for “en­vi­ron­men­tal, so­cial and gov­er­nance.”)

A strate­gic re­view led to plans for Unilever to di­vest its so-called “spreads” busi­ness and con­cen­trate on rais­ing op­er­at­ing mar­gins to 20% (com­pared with about 15% cur­rently) and a share buy­back pro­gram. Shares are trad­ing at 50.50 eu­ros ($73.25) or 22.5 times for­ward earn­ings. There’s no stated target.

“We are long-term buy-and­hold in­vestors,” Pe­den says. “Our ex­pec­ta­tion is that the shares will com­pound value at a de­cent rate.”

An­other favourite is France­based Bureau Ver­i­tas SA, which is No. 2 in the field of test­ing, in­spec­tion and cer­ti­fi­ca­tion in a va­ri­ety of in­dus­tries, rang­ing from elec­tron­ics pro­duc­tion to min­ing.

“Banks need an in­de­pen­dent third party to ver­ify mine sam­ples, for in­stance,” says Pe­den, not­ing that Ver­i­tas is also a world leader in cer­ti­fy­ing ocean-go­ing ves­sels. Shares are trad­ing at 21 eu­ros ($29.70).

Newspapers in English

Newspapers from Canada

© PressReader. All rights reserved.