Europe supplement 2018
Equities • Fixed income • Events
While a rising tide may raise all boats, interest rates may also be on the rise and as a result investors would be wise to be picky
Europe has defied gloomy economic predictions but equity markets have been slow to react. Is this about about to change?
Identifying value in smaller European companies
The coming tightening of monetary policy has led many investors to try and minimise traditional duration risk by diversifying their portfolios
InvestmentEurope’s events consider multiple aspects of the European investment scene throughout 2018
The content of this ezine is also reproduced in the May 2018 edition of InvestmentEurope. Click here to read this edition.
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On higher tides
“It is important to note that the EU GDP is still well over €2trn below its peak seen in 2008”
– Jonathan Boyd, InvestmentEurope editor and
editorial director of Open Door Media
On higher tides
A rising tide floats all boats, is the saying.
At a macro level, EU economic growth does seem to have picked up. House prices were up 4.5% year-on-year to the last quarter of 2017 in the euro area. Inflation, albeit weak, is still inflation rather than deflation. And both exports out of the EU and trade intra-euro area have risen over the past year.
However, it is important to note that the EU GDP is still well over €2trn below its peak seen in 2008. And there is a reason the European Commission continues to focus on policy intended to facilitate investments – because of concerns over an investment gap when comparing the single market to other developed markets globally.
For the fixed income investor these are also slightly uncertain times. The cost of money looks like it will go up. After tapering ECB and Bank of England quantitative easing measures, the next step is to push rates back to historical levels – possibly, but not necessarily, a good problem to have if it reflects broader economic recovery, and corporate ability to repay debts and make investments for future growth.
As such, being picky may be the best path forward. Indeed, this is what commentators included in the features of this supplement have suggested. Read on to gauge if you agree with them.
Gains made, but there’s
much more to play for
Gains made, but there’s much more to play for
Europe has defied economists’ gloomy predictions but the good news has been slow to reach the equity markets. Cherry Reynard looks at the reasons that might be about to change
Europe could justifiably claim to have made progress in 2017. It put some undoubted political risks behind it, notably in France, Holland and – just about – in Germany.
The eurozone economy continued to expand, even in some hard-to-reach places such as Ireland and Spain, as quantitative easing worked its magic. Bank lending gathered momentum and the region appeared to be on track for a sustained recovery.
The strength of this recovery surprised economists during 2017, who at the start of the year had predicted growth of just 1.3% for the eurozone as a whole. The final tally for eurozone output over the year was 2.3%, the strongest in a decade.
But more recently, economists have started to question the strength of the eurozone recovery. There has been some weakness in key indicators. German industrial production fell by 1.5% in February, month on month, for example.
The higher euro has proved a drag and there are concerns that the region is not capable of generating a self-sustaining recovery without quantitative easing.
Hugh Cuthbert, manager of the SVM Continental Europe fund, is concerned about the economic backdrop in the region: “GDP growth remains lacklustre. We’re starting to see growth being delivered but it’s nowhere near trend growth.
“At a macro level Europe isn’t firing on all cylinders or at full capacity. There are potential risks on the horizon; the Russian situation, a potential global trade war, the Italian political situation; though these aren’t necessarily systemic, or guaranteed to occur.”
“We believe there is still potential for surprise on the upside, especially after the recent pullback, and if you’re a stockpicker you can still find cheap stocks”
Hugh Cuthbert, SVM Continental Europe
Others are more sanguine: Mike Ingram, chief market strategist at WH Ireland, says: “Recent purchasing manager index (PMI) data does indeed suggest that European growth momentum peaked in the first quarter of 2018. However, this has not prevented European growth forecasts rising on a broad front for both this year and next.
“Given that the eurozone economic cycle significantly lags that of both the US and UK, this growth is in large part non-inflationary and ensures that the ECB is likely to keep rates on hold for another year or so.”
The ECB’s response will be crucial. Cuthbert points out that the ECB has been reasonably consistent to date, so there’s no reason to assume it will take its eye off the ball now. The complex political situation in Europe does not lend itself to quick decisions, he argues, so knee jerk reactions remain unlikely.
Peter Westaway, chief economist at Vanguard, says that the ECB will be pragmatic: “The big uncertainty is will these conditions be sustained when monetary easing is taken away… but the ECB will be very careful in how they remove stimulus. They are not matching the Federal Reserve. We see a slowdown in quantitative easing by the end of the year and no rate rise until June of next year.”
It is not all bad news. Laurent Clavel, head of economics of AXA Investment Managers points out that improvements in the labour market are allowing a reduction in precautionary savings, boosting household consumption, while companies are still reporting accelerating investment spending.
A secondary problem is that with the exception of a brief rally following the election of president Emmanuel Macron in France, European markets haven’t performed particularly well in 2017 relative to their developed market peers. They have done better than the UK, which has its own idiosyncratic problems, but they have lagged the US and Japan.
This weakness has continued into 2018, with stock market performance within Europe a mixed bag. Countries such as Germany, Ireland and Switzerland have been particularly weak, while France and the Netherlands have done better.
The stand-out market for the year to date has been Italy, slightly surprisingly given its uncertain political situation. Markets had factored in an even worse outcome.
If the global economy turns down, there is a risk that this ‘catch-up’ will never happen. Global investors will turn to other, more defensive markets and Europe will never have its moment.
This optimism or pessimism tends to inform investors’ relative positioning, the sectors they are targeting and whether they are positioned for more cyclical growth.
Clavel says: “Our asset allocation reflects continued growth momentum, our expectations of slowly rising rates and unpriced uncertainty.
“We remain overweight growth-sensitive assets (such as European banks), with some qualifications… Spain and Portugal are performing particularly well.”
Ingram is looking at the European consumer, which should be buoyed by a steady fall in the unemployment rate and a strong euro supporting domestic demand: “While that same strong euro is a potential drag on exports there are a number of European companies that retain pricing power and are well-positioned to capture emerging market growth.”
He believes there may also be opportunities among restructuring plays and that the recent market volatility has thrown up some interesting relative value opportunities, adding: “Does it make sense that the Italian market has outperformed Germany by some 10% so far this year? Probably not.”
Cuthbert says that it is a time to be discerning: “There’s an increased need for deeper scrutiny and selectively because of where we are in cycle. You can’t just look for cheap stocks, you also need to see a catalyst that will in time give the market good reason to rerate that valuation. You also have to be wary of value traps – after markets have gone up so much, if anything’s still cheap, there’s likely to be a reason.”
He likes oil and oil services, picking companies such as equipment provider Schoeller-Bleckmann.
He points out that in spite of the introduction of electric cars, which has scared some investors away from the sector, demand for oil is still growing globally. The sector is out of favour and still looks relatively cheap.
He adds: “Autos are another area it’s easy to write off, given the potential disruption of electric vehicles. Here we invest in companies like Germany’s Hella, which develops and manufactures lighting and electronic components and systems for the automotive industry.”
‘SCOPE TO GROW’
Most believe that European valuations look reasonable given the growth prospects.
Westaway says: “I believe there is still scope to grow. Valuations are probably not too far from historic averages. They might be in the slightly over-valued camp.
“Certainly, relative valuations in Europe are lower and there appears to be more value than in other markets.”
Cuthbert believes there is some truth to the argument the market is stretched and expensive as for the last two or three years share prices rises have outpaced earnings moves, but that doesn’t necessarily mean stocks are overvalued.
He adds: “We believe there is still potential for surprise on the upside, especially after the recent pullback, and if you’re a stockpicker you can still find cheap stocks.”
Europe is a large and diverse market. Westaway believes that while there are risks and some softening in the data, the trend is still positive.
For investors, there is more to play for, even if the easy gains have been made.
“I believe there is still scope to grow. Valuations are probably not too far from historic averages. They might be in the slightly over-valued camp. Certainly, relative valuations in Europe are lower and there appears to be more value than in other markets”
Peter Westaway, Vanguard
Identifying value in smaller European companies
The EI Sturdza Strategic European Smaller Companies Fund
Identifying value in smaller European companies
An unprecedented wave of political and economic uncertainty in Europe over the past few years has created significant opportunities for investment teams to uncover real value in Europe’s small and mid-cap equity markets. Bertrand Faure, Portfolio Manager of the EI Sturdza Strategic European Smaller Companies Fund (the “Fund”) has successfully navigated these markets, identifying undervalued companies with high upside potential.
Bertrand Faure, Portfolio Manager, EI Sturdza Strategic European Smaller Companies Fund
Faure believes that European markets currently have better valuation fundamentals than the US markets (Bloomberg shows a PE 18 of 14.2x for EuroStoxx 600 vs 16.6x for S&P 500, dividend yield of 3.5% vs 2.0%). As a result, he anticipates that European markets should offer better opportunities due to the anticipated rise in interest rates, regardless as to whether there are three or four rate hikes in the US this year.
Similar to other comparable market corrections experienced in the recent past, such as the correction after the Brexit vote in 2016, new opportunities will inevitably arise within the team’s investment universe. Consistent with the team’s investment philosophy, the focus remains on the identification of companies that create sustainable value for their shareholders.
Bertrand believes that over the long run Free Cash Flow generation is by far the best protection against negative market movements, and that companies that can generate between 8% and 10% free cash flow will remain better investment propositions than a 3% treasury bill, although the market sometimes needs time to recognise this.
The recent market volatility has created investment opportunities in high quality companies within the Fund’s universe at compelling levels, providing significant upside potential.
The team’s investment philosophy has remained consistent since the Fund’s inception in May 2015, utilising a repeatable fundamental bottom-up stock picking process to generate proprietary ideas.
Typically the Fund invests in businesses with predictable cash earnings and high or rapidly-improving returns on invested capital, barriers to competition, positive free cash flow and clean or rapidly improving balance sheets. In many cases, these businesses are family-controlled firms and can deploy capital much more rapidly than their peers.
The investment team conduct their own research in-house and construct more than 50 new financial models each year, which allows them to screen for new investment ideas.
This process allows the team to quickly deploy capital in great businesses at compelling entry points when volatility impacts the market.
“Once a suitable business is identified, the investment team will continue to monitor and model the balance sheets of these rapidly improving companies, providing an indicator of whether the current share price offers the desired risk/return profile prior to a position being established”
Bertrand Faure, EI Sturdza
Once a suitable business is identified, the investment team will continue to monitor and model the balance sheets of these rapidly improving companies, providing an indicator of whether the current share price offers the desired risk/return profile prior to a position being established. The team will sometimes monitor a target company for many years prior to a suitable entry point being identified.
The result is a benchmark agnostic, concentrated portfolio of around 30 stocks, from an initial universe of more than 2,000 Western European companies with a market cap of up to €5bn. Maintaining a concentrated portfolio allows each position to contribute meaningfully to the Fund’s total return.
The team invests with a long-term mindset, as such core positions are commonly held for two or more years.
Given the Fund’s investment universe, capacity is limited, and the Fund announced in 2017 that it would soft close when assets reach €230m, with a view to hard closing to new investments at €250m.
Asset growth has increased over the past 12-18 months and as such it is anticipated that the soft close limit will be reached in the near term.
We believe the decision to limit capacity is in the best interest of our valued investors and will ensure that the Fund can continue to deliver its investment objective.
Discover excellence across Europe.
The value of the funds and the income which may be generated from it can go down as well as up and therefore investors must be able to bear the risks of a substantial impairment or loss of their entire investments.
E.I. Sturdza Funds Plc and its sub-funds, are Irish funds authorized by Central Bank of Ireland. This communication is issued in Guernsey by E.I. Sturdza Strategic Management Limited which is regulated by the Guernsey Financial Services Commission. Any investments or investment services mentioned on this communication are not intended for retail customers. Consequently, this communication is only made available to professional investors and eligible counterparties and should not be relied upon by any person that does not possess professional experience in relation to investments. If you are in any doubt as to whether you possess suitable experience in relation to investments please consult your financial adviser. Under no circumstances should this document be forwarded to anyone in the United Kingdom who is not a professional client or eligible counterparty as defined by the FCA. The information contained herein is estimated, unaudited, may be subject to change and reflects the performance of the relevant funds during the period indicated. Any opinions or estimates expressed herein are at the date of preparation and are subject to change without notice. No such opinions or estimates constitute legal, investment, tax or other advice. This document is intended for information purposes only and is not intended as an offer or recommendation to buy, sell, or otherwise apply for shares in the funds.
When a hunt for yield turns into a spread scare
When a hunt for
yield turns into a spread scare
The coming tightening of monetary policy has investors questioning how to view their European debt exposures. As many investors try to minimise traditional duration risk, they are diversifying their portfolios with FX, corporate and credit risks, as Lukas Sustala reports
“Zinswende, wo bleibst du?” the German asset manager Flossbach von Storch asked recently in a note
“Where is the reversal in interest rates?” is a question that has not only the interest of private investors with their savings accounts, but also institutional investors, insurance companies and family offices in the DACH region.
Interest rates may have risen in the US significantly, but the spread between 10 year treasuries and 10 year bunds has risen significantly too. Rates in Germany for instance have only risen half as much as those in the US, and the rates in other parts of Europe have even declined or stayed roughly the same.
Nevertheless, many asset managers and investors agree that rising rates are here to stay and challenge the bond parts of many portfolios.
For Monika Rosen, head of Research for Bank Austria Private Banking, it remains significant for investors to analyse what is happening in Frankfurt and Washington.
The recent “mini-step” by the ECB to tighten policy – policy makers are no longer saying that they might step up their large scale asset purchases – adds to the tightening process undertaken by the Fed.
“Therefore we are underweighting bonds in general and European government bonds further, and remain selective for corporate bonds and highly cautious for High Yield,” she says.
This view to reduce bond exposure is echoed by many asset managers, who recommend to underweight traditional Fixed Income segments in their strategic asset allocation.
Analysts at Morningstar in Germany have recently looked at three different strategies to cope with an environment of rising rates in bond portfolios: Reduce duration; go flexible; and do nothing. Their reasoning was clear: If central bank rates are on the rise, investors have only a couple of options to work with that. Either they might reduce duration risk or choose truly active strategies.
Indeed, a couple of investment funds that attracted heavy inflows over the past quarters in Europe have clearly been falling in the second category, promising a very active exposure to various risks in the bond markets rather than a passive strategy.
Those opportunistic plays could benefit regardless of the overall rate rise, but add managerial risk.
The third option, “do nothing”, might apply only to those investors who seek the diversificational benefit of the bond segment of a portfolio, wrote Ali Masarwah of Morningstar.
Looking at current allocations and talking to portfolio managers and selectors, InvestmentEurope has seen very different takes on the current market environment for bonds.
Even as most allocators agree that a significant Zinswende in Europe is still a while away, bond positions vary widely regarding duration and credit risk exposures.
Some portfolio managers, for instance at Private Bank Semper Constantia, recommend to underweight government bonds and still hunt for yield in High Yield and EM positions, as the global economy is expected to grow further.
Other investors however reckon, that a paradigm shift might have occurred, also in European Fixed Income, as inflation and growth expectations have both picked up recently.
Indeed, bond markets today “are in a different environment than six months ago“, says Felix Düregger, Fixed Income manager for Schoellerbank in Salzburg, Austria. Interest rates in the US have climbed significantly, leaving rates in Europe behind. At the same time though, inflation expectations have risen steadily in Europe too.
At Schoellerbank, Düregger has a strong preference for inflation-linked bonds with a longer time to maturity. Supply in this regard has been ample, the start to the year so the strongest issuance to date.
“Since 2017, inflation expectations in Europe are on the rise. In this environment we recommend a strong dose of longer term inflation-linkers”
Felix Düregger, Schoellerbank
“Since 2017, inflation expectations in Europe are on the rise. In this environment we recommend a strong dose of longer term inflation-linkers,” he says.
The recent upward pressure on the euro has made it difficult to benefit from foreign exposure as a euro-investor. Yet at Schoellerbank, Düregger and his team still recommend a broad diversification in terms of non-Eeuro exposures. Whether it is the appreciation of the Swedish krona or a carry from emerging markets currencies or idiosyncratic stories like the Russian rouble, currency markets from time to time might offer return potential.
Not only are currencies a diversification to consider, for a long time credit spreads have been an essential source of added returns in an environment of low government bond yields.
Most asset managers exposed to European bonds have been strongly diversifying into credits. But Ingrid Szeiler, CIO of Raiffeisen KAG in Vienna, recently warned that there still lingers the threat of a reversal in high yield flows in capital markets.
“The coming end of large scale asset purchases by the ECB has become a matter of reflection for many bond investors in Europe,” he says.
A further rise in spreads might thus be on the table. It is still possible that the nearly decade-long “hunt for yield” changes into a “fear of spreads”, the team at Raiffeisen warns. Bonds are generally underweighted in their strategic asset allocation, due to the low yield level (government bonds) or the valuations (high yield).
But rising rates have also brought some good news with them, argues Bernd Meyer, chief strategist Wealth and Asset Management at Germany’s Berenberg Bank.
At year end 2017, 23.5% of all European investment grade bonds yielded less than 0%. This has fallen less than 10% of such bonds at the beginning of March. Overall, the opportunities in Fixed Income will not be in government bonds, but rather in corporate debt, says Meyer. And those opportunities have become more plentiful as rates have risen.
THE GREAT DIVIDE
Other asset managers still see the European capital markets divided by a stark line between “core” and “periphery”.
Frank Engels, head of Portfolio Management, and his team at the Investment Committee of German asset manager Union Investment, recently stated in a note to clients, that they currently see most opportunity in eurozone peripheral debt, this being their only overweight within the advanced economies Fixed Income space.
The yield on 10-year Spanish government bonds has dropped to 1.2% lately, but still offers a yield pick-up of nearly 70 basis points compared to German bunds.
The fund manager for an Austrian asset manager remarked in a discussion that “it is of increasing importance to look at the liquidity of the chosen instruments. If something happens due to central bank comments or political volatility, we do not want to end up in the illiquid part of the market”.
Illiquidity might sound like an odd criterion in a time of huge central bank balance sheets, but “we don’t want to get caught”. And recent volatility in Russian or Turkish markets for instance has proven how political risks are behind the significant yield premia in Emerging Europe.
Whether investors divide their European portfolios according to currency exposures, credit risks, core/periphery or duration, Mickael Benhaim, head of Fixed Income Investment Strategy & Solutions at Pictet Asset Management, recently made a strong case for an active strategy to deal with the current environment and called out a number of problems with passive bond strategies.
“The fundamental problem is that bonds simply don’t lend themselves easily to passive investing.”
For instance, duration risk today is significantly higher than a decade ago, making passive strategies more prone to a rise in interest rates.
Adding to that traditional capitalisation-weighting of indices mean that bond strategies are strongly tilted towards highly-indebted companies or countries.
And if an investor prepares for an environment of rising interest rates, one thing might be an obvious choice: Treating those segments of the bond market that are more significantly indebted than others with heightened caution.
InvestmentEurope’s programme for 2018
InvestmentEurope’s programme of events through 2018 will include the participation of investment professionals discussing various facets of European equity and fixed income, and including both active and passive approaches
Access to latest thoughts is made possible through all three types of events laid on by InvestmentEurope: Roundtables, Forums and Summits. Recent speakers have included:
Neil Brown, Liontrust, speaking at the Zurich ESG Forum
Derek Fulton, CEO First Trust Global Portfolios, who discussed “AlphaDEX® Select Opportunities in the Eurozone: Value and Growth” at the Nordic Summit Stockholm 2018 (download here).
Neil Brown, investment manager – Pan European Equities – Liontrust, who presented the Liontrust Sustainable Future – SF Pan European Fund at the Zurich ESG Forum 2018 (download here).
Looking forward, there are many other Europe focused presentations set to be delivered at future events.
For example, Diane Bruno, portfolio manager at Mandarine Gestion is outlining “Mandarine Unique – a ‘unique’ way to invest in European Small- and Mid-Caps” at the DACH Summit 2018 taking place 15-16 May (further information is available here).
Events set to take place over the next few months of 2018 include:
DACH Summit Munich 2018 on 15-16 May.
Barcelona Roundtable 2018 on 31 May.
Oslo Roundtable 2018 on 7 June.
Swiss Summit 2018 on 7-8 June.
Reykjavik Roundtable 2018 on 13 September.
Lisbon Roundtable 2018 on 27 September.
For further information on these or any other InvestmentEurope events visit:
There you will find the lowdown on venues, keynotes and the speakers attending the portfolio of events laid on across Europe and elsewhere.
Local. Informed. Connected.
In its quest to serve the information needs of financial services professionals around the world through its digital products, publications and conferences InvestmentEurope has announced a full calendar of events for 2018 for Europe and the US Offshore market. If developing relationships with the leading fund selectors in Europe is important to your marketing and distribution strategy, click here.