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As New Star's European Growth fund moves back into the top 10% of funds in its sector (in terms of performance) manager Richard Pease concedes it had a disappointing 2007, but contends it's now well positioned to weather the upcoming storm.
Pease says: "The period of underperformance encouraged us to go through the portfolio with renewed vigour and concentrate on the high conviction holdings.
"There were no sacred cows. We cut our losses on several banks, moving underweight in the sector, and also cut our positions in erstwhile favourites such as C&C Group, the Irish drinks company, and MAN, the German truck maker."
While the exposure of the portfolio to industrial cyclical stocks has been reduced, it retains an overweight position because Pease believes there are plenty of quality companies in this sector.
Industrials are a broad church. For example, the lift company, Schindler, is classed as an industrial cyclical, yet more than 75% of its earnings come from service contracts. Clearly, fewer new lifts are needed if global construction slows but refurbishment programmes and health and safety legislation mean that maintenance demand should remain buoyant, as does emerging market demand
Pease believes there is a disconnection between the nervousness in the financial markets and what is happening in the broader economy.
He says: "At the risk of sounding like a broken record, the message being received from company managements is different from that being broadcast by economists."
He points to the recent good earnings results season as an indication that European companies outside the financial sector are doing reasonably well. And he believes the sense of foreboding is distracting investors from some of the excellent value in the market.
"There are obvious areas of pain, consumer credit is harder to obtain and financial stocks and highly-leveraged players are struggling, but these are the areas we would expect to suffer in a credit crunch," he says.
"The companies we speak to describe robust conditions and this is supported by recent strong economic data, such as rising German exports in January and higher French industrial production. Many holdings are reporting long order books and high cash balances; they go into any downturn better prepared than they have probably been in a generation.
"Other stocks in the portfolio are benefiting from some of the markets concerns. K+S, the fertiliser group, has risen strongly on the back of higher food prices while Fortum, the Finnish power group, has climbed on higher energy prices."
Even those companies in the thick of the storm, such as Randstad, the Dutch recruitment company, and Grafton, the Irish builders merchants, look appealing.
Pease notes: "These are not ridiculously overvalued dotcoms with barely-fleshed out business models but fundamentally sound companies. Management are clearly confident as they have respectively engaged in acquisitions or bought back shares."
"In the near term companies are likely to want to conserve cash and preserve strong balance sheets but the opportunity to do deals - even at big premiums for a fraction of the prices possible a year ago - will tempt buyers back," he says.
The portfolio has a weighted estimated free cash flow yield of 9% excluding financials. Such a level discounts a lot of potential pain and is also likely to flush out predators keen to take advantage of the low valuations among the companies held.
On the economy, Pease is sanguine about the stoicism of the European Central Bank (ECB) arguing that the ECB is determined to prove it isn't soft on inflation; hence aggressive rate cuts are unlikely on this side of the Atlantic even if you think Europe is merely lagging events in the US.
The sensible bet, however, is that the ECB isn't going to vote for a Kamikaze recession. If conditions deteriorate, rates will be cut. Its participation in the concerted boost to liquidity in March shows it is prepared to act when necessary.
07 April 2008 © Moneyextra.com
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