Roam-anywhere fund hits the top

Barry Norris of Neptune won’t forget 2004 in a hurry. Not only did he get married, but he also managed to run the best-performing Europe fund in the first quarter, the third quarter and the fourth quarter. The second quarter was when he was on honeymoon.

Neptune European Opportunities was up 31% in 2004, compared with the 10% average return for the sector. Its success is due largely to a clever series of bets on the oil sector in its widest sense. Some of the big European oil majors are in his portfolio – Total of France is his ninth-largest holding, but rather more important are Maurel et Prom, Saipem, Technip and Frontline. No, I hadn’t heard of them either, but they all benefit every time we pay £50 to fill up our motor.

Saipem of Italy and Technip of France are Europe’s two largest oil seismic surveying companies. Norris believes there are some pretty desperate supply-side constraints in the oil business, which means that money will have to be poured into the surveyors to find new reserves.

“There’s only one million barrels of spare capacity in the world. The world uses 84 million barrels a day, and that one million of spare capacity is entirely within Opec. The non-Opec countries are pumping flat out. If demand for oil rises by just 1.5% this year, all that spare capacity will be gone,” he says.

Given that view, he’s pretty confident that the oil price will stay high. He even thinks he has spotted another Cairn Energy: Maurel et Prom, a French exploration and production company. It has found a 250 million-barrel field in the French Congo and owns 65% of the site. It shares the find with Burren in the UK, but Maurel et Prom is on a much lower rating than Burren.

What’s more, Norris is convinced that 250 million barrels is a very low estimate: “We think that figure will be revised upwards very significantly. It puts the stock on a very low multiple.”

Then there’s the business of actually shipping the stuff when you’ve found it. The world’s largest fleet of oil tankers is Norwegian, owned by a company called Frontline. It’s Norris’s third largest holding and has done extraordinarily well for him amid the general re-rating of shipping companies brought on by the Chinese commodity import boom. But being in oil, Frontline will continue to benefit if the oil price remains high and demand remains firm.

Finally, there’s the processing and refining of crude oil once it reaches its destination. Here you’ll find some of Norris’s most interesting plays. He has taken stakes in Mol of Hungary, ERG of Italy and Motoroil Hellas of Greece: “Not enough has been spent on refining capacity in recent years. Shareholders of the oil majors have told them to focus on return on capital, and they have significantly under-invested. Yet stocks such as Mol trade on very modest multiples of just seven or eight times earnings.”

But this fund is not some energy portfolio in disguise: it is 25% in energy and 27% in industrials, but it’s also 24% in financials. Norris’s holdings in financials are largely down of a belief about the development of retail financial services markets in the emerging economies of Eastern Europe.

As these countries become more integrated into the EU, the demand for mortgages, credit cards and personal loans will increase dramatically, especially compared with the saturated markets of western Europe. Norris particularly likes OTP Bank in Hungary and Hansa Bank in Estonia, a country he thinks is going to develop very rapidly.

But he’s no fan of Russia, which shows how independently he operates compared with Neptune boss Robin Geffen, one of the early apostles of the opportunities lying east of the Volga. Norris at one time had 10% invested in Russian equities, but in early May took this down to zero. It was a good call, given the fact that the Russian equity market peaked in April.

At this stage, you might be thinking that this boy is a bit risky: Estonian banks, Hungarian refiners, focused portfolio. Not a fund to let you sleep at night. But although it is a roam-anywhere fund, Norris insists the performance hasn’t been achieved by taking huge risks.

“We have had a tracking error of 8%. To produce a return on the fund of more than 20% above the index with a tracking error of 8% is not bad at all. There is less than a one in 300 chance of that happening on a normal distribution curve. We take the risk of capital loss very seriously in this fund.”

He runs the fund with between 35 and 50 stocks, and none is allowed to go above 5% of the total portfolio, which is currently about £26m in size. The stock universe is made up of companies with market capitalisations above E800m (£562m) – even Hansa in Estonia has a market cap of E3.2bn.

The fund was launched only in November 2002, which is why it has had only small inflows so far. But it will probably become a classic fund of funds vehicle. Indeed, it was set up on the advice of Mark Harris, now at New Star but at the time at Edinburgh Fund Managers, where he ran a fund of funds. He wanted a European focus fund and had the foresight to seed the Neptune fund from the outset.

One major drawback is that it is difficult to stoke up much enthusiasm among retail investors for Europe, especially given the endless stream of bad economic news flowing out of Germany. It frustrates Norris: last year, Europe was one of the best-performing stockmarket areas, while China was among the worst. But guess where retail flows are heading. Europe ex-UK is on 14x earnings, while Hong Kong’s Hang Seng index is on 17x. Yet European dividends are covered two times by cashflow, and the dividend yield is 3.3% – only a touch below the bond yield of 3.5%.

“European equity valuations look extraordinarily attractive on a global basis,” insists Norris. But he admits that after a stunning 2004, he is understandably nervous about being able to do it all again in 2005.

PATRICK COLLINSON
The Guardian Personal Finance Editor