The investment landscape is more uncertain than this time last year and for some time we have felt that world markets needed to curb their enthusiasm. Donald Trump’s protectionist policies are likely to have a ripple effect on world trade, while the weight of ETFs has pushed valuations in the US higher.
Coming off the back of the strongest period of synchronised global growth since the financial crisis, market optimism has been understandable, but the reality is that we are still in a low growth world and volatility is creeping back in to global markets. It is all too easy to get carried away with the recent growth story, but it’s important not to extrapolate this as the new normal. At Henderson EuroTrust, we are putting more and more emphasis on total return as global growth cools back to familiar levels.
Europe’s performance during the recent boom is something to take note of, however. Last year saw the Eurozone post its best annual growth rate since 2007, outperforming the UK for the first time since 2010 – and by some distance. The Eurozone’s annual GDP growth rate in 2017 came in at 2.5%, while the UK only managed 1.8% — and it even beat the US, which grew at 2.3% last year. It’s a testament to the region’s recovery and it’s fair to say Europe is in its best shape since the crisis and lays a strong claim to be the default diversifier to UK portfolios.
Europe’s long-term focus
Looking over at the UK, it would be easy to pick on its troubled political landscape, but global politics is in such a state you could find problems just about anywhere, after all – politics is a useful distraction to the underlying problems, anywhere in the world. From an investor’s perspective, my concern would be more towards short-termism in the UK, which completely undermines sustainable long-term growth. This point was outlined well in an article by the Financial Times recently (08/04/2018), titled “Lazy fund managers lead to lousy returns” by Tom Brown.
UK equities are seen by some as good value at present, with the worst of Brexit seemingly priced in. Although this might sound like good news for Brexit optimists, a concern would be the potential for hostile takeovers – as seen with industrial manufacturer GKN – and opportunistic investors keen to raise the share price and make a quick profit. I remain of the view that Brexit is a monumental wrong step by the UK, which will not solve any of the UK’s underlying problems.
It is much more difficult for such short-termism to prevail in Europe, where many countries have a long term shareholder in a foundation or family, such as Arnaud in France and the Quandt family in Germany, for example. This allows companies to take a far longer investment time horizon and in most cases long term financing is cheaper anyway. As a result, European companies, by and large, have a greater focus on long-term sustainable growth than their UK peers.
European markets have not followed through on a positive sentiment which was evident in early 2017, even though the economic and political environment has improved, more so in the case of economies perhaps than politics. Recently, the region seems to have taken the brunt of investors’ wrath, even though valuations, interest rates and the region’s high-paying dividends season all should be supportive. Most companies in the region pay one lump-sum dividend between March and the end of June, and with strong earnings growth in Europe the EuroTrust has been a beneficiary.
The Trust has a strong dividend paying history – last year we paid an annual dividend of 25p per share and have increased the dividends for 13 consecutive years. We aim to continue this trend and I’m confident that the recent dividends paying season in Europe will help us achieve that this year, although nothing is guaranteed.
Cyclicals look expensive
In terms of stock selection, we are looking for companies with strong and sustainable growth potential. Generally speaking, we think valuations on economically sensitive stocks – ‘cyclicals’ – are stretched compared to more defensive stocks. This is based on current price-to-book ratios, which we think are more useful than price-to-earnings ratios at this point in time, owing to the fact that many cyclical companies are showing above-average and potentially unsustainable margins. It’s an interesting point because it’s only the second time that cyclicals have been more expensive relative to defensives since 1995.
We are therefore avoiding cyclical stocks and topping up on companies that have sustainable businesses with room for growth. For example, French cosmetics company L’Oréal is a stock we like – not because it is a defensive stock but rather it has a solid business that we think can grow in a low growth environment.
The Trust’s gearing facility was recently increased to £25 million, which would represent about 10% of the portfolio if we utilised all of it. At the same time, the Trust’s portfolio list is at its shortest for some time at around 45 stocks – down from 58 in April 2017. The portfolio is also much more weighted towards our top 10 holdings – 35% compared to less than 30% in December 2016.
We intend to use the gearing facility prudently and we have been using market weakness in February and March to top up on existing positions, such as Deutsche Post, Geberit, and Amundi amongst other.
We have also topped up on Europe’s unsung tech heroes, namely Spanish IT group Amadeus and German business intelligence software provider SAP. Contrary to the general consensus, Europe’s tech leads the world in some areas. We have held SAP and Amadeus each for a long time and have been beneficiaries of their growth.
At the end of March, Henderson EuroTrust shares were trading at a discount to the underlying NAV of about 7.5% and although that may well narrow over the coming months, it also has potential to widen if sentiment towards European equity markets deteriorates further. But as a snapshot, an Investment Trust trading at a higher than usual discount compared with what has been the case in recent years might from time to time offer a good opportunity for a long term investor.
Looking at the wider picture, world economic growth might just be at that “as good as it gets” moment. GDP growth rates are slowing down but Europe’s emphasis on long-termism and innovation is a combination we think will lead to sustainable growth. Strategically, we think Europe will be one of the more fruitful areas for growth investors.
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.
Total return: The return on an investment, including income from dividends and interest, as well as appreciation or depreciation in the price of the security, over a given time period, usually a year.
Price-to-earnings ratio (P/E ratio): A popular ratio used to value a company’s shares. It is calculated by dividing the current share price by its earnings per share. In general, a high P/E ratio indicates that investors expect strong earnings growth in the future, although a (temporary) collapse in earnings can also lead to a high P/E ratio.
Price-to-book ratio: The price-to-book ratio (P/B Ratio) is a ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. Also known as the price-equity ratio.
Gearing: A measure of a company’s leverage that shows how far its operations are funded by lenders versus shareholders. It is a measure of the debt level of a company. Within investment trusts it refers to how much money the trust borrows for investment purposes.