Why RLAM swapped European income for growth

With his Royal London European Opportunities fund in the top 10 performers out of 102 funds in its sector, Neil Wilkinson remains confident about the prospects for stocks, if not necessarily for the economies, in the much derided eurozone

Collinson-Patrick-2014-700.jpgNeil Wilkinson admits that since the start of the global financial crisis – and its ever-sickly offspring, the eurozone crisis – it has been an uphill battle to convince investors to take the continent seriously. But amid growth projections lowered yet again by the European Commission, banks failing stress tests and earnings forecasts downgraded, he remains confident about the prospects for stocks, if not necessarily economies.

He has reasons to be cheerful. His Royal London European Opportunities fund is among the top 10 performers of the 102 funds in its sector over one year. But although this £250m fund has performance stats going back years, they are largely irrelevant, because it went through a wholesale portfolio change in July. Even since then it has been a star performer.

Oddly enough, in an era where we are told investors are chasing one thing – income – they don’t seem to want European income. British investors who want something other than UK equity income are making the leap to global income. Unloved and unwanted, Royal London Asset Management decided to abandon its European Income fund and turn it into a focused growth fund – yet on sites such as Trustnet it has inherited its former performance stats.

Wilkinson created a portfolio of just under 40 stocks, launched on 1 July, which he reckons can generate serious alpha. The top two names (Roche and Novartis) are each 6 per cent of the fund, while the next five are all punchy 4 per cent-plus positions.

royallondon

Wilkinson’s background from his days managing portfolios at Hermes is in small and mid-cap European stocks, but this fund is 85 per cent large cap. He says: “I will delve down into small caps, where I have extensive experience, but they are looking expensive and tend to underperform when the Fed is in a tightening cycle as it is now. Small caps in Europe had a phenomenal run in the five years to March 2014, but they have been underperforming since then.”

That said, one of his strongest performers has been the German semiconductor company Dialog, up 37 per cent over the past three months alone, despite choppy markets. The €2bn market cap company makes power management chips for Apple iPhones and it has jumped since the successful launch of the sixth iteration of Apple’s money spinner.

The other stock that has taken off for Wilkinson has been Ryanair. It reported its first-half results last week and said profits soared by 32 per cent to €795m (£621m) on the back of a 5 per cent rise in passenger numbers as it tried to shake off its image of poor customer service. Its shares have risen from £5 to £8.50 over the past year, with most of the gain over the last month.

Maybe it is his institutional background, but while this is a focused, targeted portfolio it is also a low turnover fund. “I am a bit of a buy-and-hold merchant and I tend to take a fairly long-term horizon,” Wilkinson says. He has also revised his approach to running money since the financial crisis.

“Pre-crisis I would have said it’s all about stock selection, but now I worry more about the macro. As a manager of European stocks you simply can’t not take a view on the macro. but if you decompose the risk dynamics of this fund, you find that 60-70 per cent of returns still come from stock selection.”

Wilkinson’s biggest top-down no-no is the European utility sector. “It’s not an attractive space to be in with extensive regulation and companies subject to political whim.”

His major sector bet is pharmaceutical stocks. “On the big-picture front I am strongly in favour of the pharma sector over consumer staples. As industries they have similar characteristics but pharma is trading on P/Es  of two-to-three less than staples. So you’ll see that I have Novartis, Roche and Bayer in my top 10 but I don’t own any Unilever.”

There does seem to be a northern European bias in the fund but Wilkinson says that largely reflects relative market capitalisation.

“If you look at Portugal, Greece, Italy and Spain, the fund has 10 per cent there but that’s not especially low as they make up just 12 per cent of the index.”
What might alarm some investors is that the biggest geographical allocation in the fund is to France – the country currently cited as the sick man of Europe.

Wilkinson is not inclined to disagree but points to the fact that his 24 per cent weighting in the country comes from French stocks with an almost entirely international flavour.

“Look at Axa [the fund’s third-largest holding], it’s a global insurer. Then there is Neopost, which holds a virtual duopoly with Pitney Bowes in the global postal machinery market. Airbus comes third and although it is headquartered in France it is as much a German company, while Schneider Electric has a lot of US exposure.”

But it comes back to investor perceptions. “It’s a tough job for any European fund manager to get people to invest in this asset class. But what some people are failing to understand is that Europe has some world-class companies on good valuations.”

On a P/E basis Europe is not particularly cheap, which Wilkinson puts down to where European companies are in the earnings cycle, but on a price-to-book basis they are a buy. He reckons 2015 could be a good year for European equities, with earnings downgrades falling out of the picture and a lower euro powering a strong revival in one of the continent’s most powerful weapons – exporting companies.

Key takeaway In July this year Royal London AM changed the mandate of its European Income fund, turning into one focused on growth. Manager Neil Wilkinson runs through the changes which have brought about a lot of initial success in a much unloved region.

wilkinson

Neil Wilkinson, fund manager, Royal London European Opportunities

Neil Wilkinson joined RLAM in January 2012.  He was previously director, European small and mid cap at Hermes Fund Managers. Prior to Hermes, he was a portfolio manager at AIG Global Investment Corp and a sell side analyst at Cazenove & Co. He has a BA in economics from Durham University and is a CFA Charterholder.