BlackRock Continental European manager Vincent Devlin tells James Smith about stockpicking opportunities against ongoing macro difficulties, with many peers advocating investment at current discounted levels.
Where do you stand on the attractions of European equities at present – do you echo some of your peers in seeing now as a good entry point?
Asset allocators have broadly been selling Europe since 2007 and even more heavily as the macro situation has worsened in recent years. Over this period, the index has been flat and our funds have been able to produce a positive return. Amid ongoing uncertainty, two things are currently clear about Europe: there are several problem areas, so an active approach to stock and sector selection is vital and after five years of selling, the discount applied to the continent’s equities is high so there is value to be found.
What about the macro picture – do you see any light emerging on that front?
Europe is faced with a heavy political agenda in the coming months and the crisis could still escalate if we see a lack of delivery by eurozone politicians. That said, the situation has actually steadied in recent months, with the possibility of a eurozone break-up looking less likely as countries rallied round the single currency.
While some departures from the euro remain a distinct possibility, the positive impact of an increasingly proactive stance by the European Central Bank is clear. More economic certainty should bring the equity risk premium down and create a more positive environment for European investing than over the last five years.
Growth will remain scarce on the domestic front with austerity policies in the ascendancy. But ECB president Mario Draghi’s Outright Monetary Transactions announcement has created a three-year window to get things back on track. The ECB’s last fiscal easing in 2009/10 only lasted a year and this longer commitment is a definite positive.
It will take time to feed through into the system but we have already seen the Euribor rate come down substantially and some Spanish banks issuing debt, which would simply not have been possible a few months ago. The major risk is that all this liquidity gets wasted but Draghi has certainly acted decisively to get the economy moving again and remove lingering uncertainties.
What has been your strategy against an extremely volatile market backdrop?
We run several European funds off a core stockpicking strategy and Continental European (headed up by Devlin since 2008) has produced alpha in a range of conditions – bear market, bull market, sideways market, risk on/risk off – highlighting the benefits of simply seeking the best 50 stocks at any particular time.
Compared with our well-known European Dynamic fund, headed by Alister Hibbert, Continental European has the same basic process with a few more constraints in place, typically taking less aggressive sector and country positions against the benchmark and smaller stock weightings.
Stockpicking drives the majority of returns and we seek five basic characteristics for holdings, although not every position will have the full set. First up is for a company to be in an industry with attractive dynamics, which has largely ruled out areas like utilities from the portfolio. Second is for the business to use capital efficiently and while many firms are sitting on cash piles amid ongoing turbulence, recent declines in the Euribor rate should feed through to lower debt costs and encourage greater corporate confidence. A third element is for the management to present a clear, explainable strategy and also have their facilities in terms of manufacturing, people and products to execute it. Last, but very much not least, are growth and attractive valuation.
With stockpicking key for performance, how important is sector positioning?
Just like with stocks,we are also keen to allocate capital to better industries. Over my tenure on the fund, this has largely been industrials and consumer discretionary, with financials a consistent underweight, along with utilities and telecoms. We are keeping in touch with a number of European banks but there remains too much regulatory uncertainty at present to invest. If we could find one that met our criteria, it would be possible to make some serious money considering current low valuations.
Elsewhere, utilities is a generally unattractive sector, struggling with excessive leverage and worsening dynamics, with electricity supply diminishing for example. Several companies have also used capital badly in recent years by accumulating poor-quality assets and we see management as pretty average in a sector with serious structural issues,
Healthcare is another area with problems but we would highlight some exceptional stocks such as Novo Nordisk, the largest position in Continental European at 5 per cent. This is a company where the market grows by 5-10 per cent every year, which is a huge advantage. Novo Nordisk has also shown itself to be extremely innovative in areas like drug delivery, creating its NovoPen for insulin injections.
Are country weightings important in an increasingly globalised marketplace?
Country positions are largely a function of stockpicking, with the team seeking businesses with global reach and domicile therefore becoming much less important. This is evident from holdings in various companies in the beleaguered Spanish market for example, with Amadeus and Inditex both among the stronger performers. With Amadeus for example, 9 per cent of the company’s sales come from Spain, and while we will analyse the effects of negative growth on this, the local market is clearly not key to overall performance.
Which stocks would you highlight as particularly beneficial for performance?
Apart from Novo Nordisk, we would also flag up Amadeus as well as the Finnish lift company Kone. Amadeus is a transaction processor for the global travel and tourism industry and a strong example of a European company with market-leading products on a global scale. The company IPO’d in 2010 and was able to meet most of our stockpicking criteria despite serious macro problems in its home Spanish market.
Amadeus has two key business areas, a basic global distribution system and an IT solutions arm. Rather than a company like BA doing its own flight booking and ticket, many are choosing to outsource and Amadeus has established itself as an international network. On top of this basic search and booking function, the group’s Altea customer management system also provides additional modules to travel businesses, automating processes such as departure control. Looking at our various stock criteria, this kind of successful software business will typically provide a good return on capital employed.
As for Kone, this is another global company benefitting from the strong recurring revenue element often key in niche areas. As well as providing new lifts and elevators for buildings across the world, Kone also offers ongoing maintenance contracts and 80 per cent of its EBIT now comes from this predictable after-sales area.