Sector Review: European Equities

of years – be it fraught Brexit negotiations, the US-China trade conflict, or a populist rise across mainland Europe – equities throughout the eurozone have suffered from the uncertainty. Despite such pessimism, there are a few strategies being employed to mitigate these risks. In this guide, we hear from Tim Crockford, lead manager of the Hermes Europe ex-UK Equity Fund, discusses his firm’s “style-agnostic” strategy towards investing in European equities. And Natixis’ UK sales head, Darren Pilbeam, gives an overview of the latest manager views from their multi-affiliate platform. While the coming year is not expected to see a return to the stability of year’s gone by, canny investors should be able to find plenty of opportunities in European equity markets if they get a bit creative.

t’s fair to say that the last year has not been a strong and stable period for the European market. Amidst the geopolitical turmoil of the last couple

SECTOR REVIEW

EUROPEAN EQUITIES

Recognising unrecognised change

Four perspectives on global equity

IN THIS ISSUE

By Hermes Investment Management

By Natixis Investment Managers

All investing involves risk, including the risk of capital loss. This material is provided for informational purposes only and should not be construed as investment advice. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of Natixis Investment Managers as of May 2019. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecast, and actual results may vary. Provided by Natixis Investment Managers UK Limited, authorised and regulated by the Financial Conduct Authority (register no. 190258). Registered Office: Natixis Investment Managers UK Limited, One Carter Lane, London, EC4V 5ER

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NATIXIS INVESTMENT MANAGERS

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Recognising unrecognised change

A long-term, high conviction approach to European equity investing

What do investors miss by not adopting an absolute return factor approach?

Stan: One of the basics of investing is to diversify one’s investments and, as such, create more robust portfolios. Factors are driven by different elements than traditional asset classes so they will behave differently and provide valuable benefits. To achieve this diversification benefit, the factors should not have structural long biases to traditional return sources like the equity risk premium. We therefore favour an absolute return approach where we avoid these types of biases and can deliver attractive returns both in bull markets and bear markets. We have proven this over the last three years. Our strategy has delivered very attractive returns, and although individual factors should not be considered the Holy Grail, we have shown that by combining multiple uncorrelated factors it is possible to generate very appealing risk-adjusted returns. To quote Aristotle: the whole is greater than the sum of its parts!

We have proven this over the last three years. Our strategy has delivered very attractive returns, and although individual factors should not be considered the Holy Grail, we have shown that by combining multiple uncorrelated factors it is possible to generate very appealing risk-adjusted returns. To quote Aristotle: the whole is greater than the sum of its parts!

Stan:

SECTOR REVIEW

EUROPEAN EQUITIES

Recognising unrecognised change

A long-term, high conviction approach to European equity investing

SECTOR REVIEW

EUROPEAN EQUITIES

Four perspectives on global equity

Recognising unrecognised change

Four perspectives on global equity

Recognising unrecognised change

his team take this view – most important is the way in which the European indices are constructed, even their own benchmark, the FTSE World Europe ex-UK. Tim, who became the fund’s lead manager in 2015, points out that over one-fifth of this benchmark is comprised of European financials. “And right now, we don’t feel comfortable putting a fifth of investors savings in European banks for any long period of time,” he states. Against a backdrop of economic and political uncertainty as well as central banks posing a systemic risk to the eurozone financial system, his point from an investment perspective is valid. These factors have led to substantial outflows from the region and throughout the globe investors have tended to underweight Europe as they wait to see how these issues play out. The Hermes investment team believe European benchmarks, more so than their global counterparts, can mask some exciting opportunities that may present themselves in the region, but get lost amongst a sea of large but structurally challenged industries. The team considers one of the key opportunities in European indices to be the huge inefficiencies associated with what’s big, and on the flip side, the glaring inefficiencies in terms of what isn’t big, when it comes to classifying benchmark companies.

o hear a European equity investment manager say that they wouldn’t buy the European market would make most of us wonder if they were trying to come across as being ironic, or facetious. But Tim Crockford, lead manager of the Hermes Europe ex-UK Equity Fund, isn’t. There are many reasons why he and

The strategy for the Hermes Europe ex-UK Equity Fund is not about buying Europe; instead, the focus is on identifying particular European equities, completely missed or underestimated by the market, with the potential for positive changes to enable it to grow its capital, and its earnings, going forward. Effectively, the fund takes a style-agnostic approach, investing in the prospect of positive change, which can manifest itself in all corners of the market, and when it finds the opportunity, it invests actively and with high conviction. The investment team refers to the fund as being style-agnostic in part because of how it purchases new ideas. It will invest in value, mid-cap companies with unrealised potential,which are gravitating towards becoming larger cap companies with their growth credentials recognised as their valuations grow throughout the holding period. “We look for stories that revolve around seeking change and unrecognised change, which leads us to corners of the market which would traditionally qualify as the value areas of the market, as well as those that would qualify as growth” says Tim. It will also buy growth companies. This is because the team may detect something in a company that is trading on a typical growth valuation, but which they believe the underlying future assumptions – for cash flows and earnings – are underforecast. The fund concentrates mostly on companies with a market cap larger than €1 billion – mid cap companies. This is because the investment team believes there are some very exciting new stories in this space which are going to emerge as tomorrow’s large or mega-cap companies. The fund typically doesn’t invest in giants because they infrequently offer an angle for unrecognised change. It also steers clear of micro-caps due to the lack of liquidity, nor does it buy into the deep cyclical space. This is because these firms are too dependent on the financial cycle for future earnings, and they are usually very capital-intensive businesses.

ALTERNATIVE APPROACH

Sartorius, a core holding, is one of a few companies to cover the production processes of the biopharmaceutical industry and the production and servicing of laboratory instruments and consumables

“...we don’t feel comfortable putting a fifth of investors savings in European banks for any long period of time”

Since becoming lead manager of the fund, Tim has introduced a more thematic approach to generating ideas. This framework was not designed to be an asset allocation tool, or a top down thematic approach to gain exposure to a particular theme. Instead it is a platform for idea generation, and the themes that are generated will then be evaluated on a traditional bottom-up basis. The team focuses its research efforts on areas of disruption. It seeks companies which are exposed to themes that drive structural growth and which are exposed to new markets and emerging product areas, rather than being reliant on the macroeconomic cycle. “If you’re looking for change that hasn’t been correctly or efficiently priced into the equities you’re considering buying, a great way to do that is to figure out what’s changing in the world,” says Tim. “To figure out where the world is moving to rather than where the world has been.” Areas in which Hermes has identified positive disruption within its thematic framework can be seen in the illustration right.

PINPOINTING POTENTIAL

Health and wellbeing is a dominant theme for the fund. A prime example of a stock that illustrates the huge inefficiency and understanding of the positive financial implications of what is changing in the wider healthcare environment is Sartorius, a core holding in the portfolio. Sartorius is one of a few companies to cover the production processes of the biopharmaceutical industry and the production and servicing of laboratory instruments and consumables. Its single-use and bioanalytics products increase the safety and resource-efficiency of the biopharmaceutical manufacturing process, while at the same time reducing the costs and increasing time-to-market of new medicines. Sartorius manufactures equipment for the manufacturers of biological drugs and the consumables that are required to operate the equipment. This provides the firm with an additional stream of revenue, as the manufacturers have to continuously replenish their stock of consumables on an ongoing basis. “When we looked at what sales mix the market was expecting [in 2014 when we purchased the stock], this growth in revenues from the consumable element really wasn’t being priced in,” explains Tim. Sartorius is now one of the fund’s best performing stocks, having gone from being a €1.5 billion company to a €12 billion firm today. It is undeniably a growth company, and the market has continuously underestimated its ability to continue to grow its earnings base over the long-run.

BENEFITTING FROM CHANGE

A more recent purchase for the fund has been a French oil services stock called Gaztransport Et Technigaz (GTT), which is very much a play on the energy transition theme. The fund bought it in 2018 when it was trading on a 7.5% dividend yield, and the market was forecasting it to have declining turnover and earnings for the next four to five years. The company is enjoying structural growth through manufacturing containment systems for the shipping and storage of liquefied natural gas (LNG) in cryogenic conditions. It is a market leader in the LNG containment systems space, and well placed to benefit as LNG trading grows, with demand driven by a need to reduce carbon emissions. The company sells the right to use its intellectual property (IP) and therefore receives a royalty stream over the course of the manufacturing of these vessels in sales, on an otherwise asset-light capital base. While its revenue is dependent on the cycle for these LNG carriers, it earns high gross margins and generates substantial cash flows. Subsequently the stock delivered some good results that suggested that the cycle was starting to turn much earlier than the team had predicted.

INVESTED IN ENERGY

Since becoming lead manager of the fund, Tim has successfully tweaked the strategy, notably by reducing the number of stocks held in the fund to its current 36 constituents, increasing its active position, and building a concentrated portfolio of high conviction holdings. Much of the fund’s performance can be linked to the team’s core investment philosophy, which is that the key to any investment is unrecognised change. “It is all about noticing something is changing, doing the work to understand whether that change could have a positive effect on future earnings and cash flows or not, and determining whether that change is actually priced into these future expectations for that particular company,” explains Tim. Change takes time, which means the fund must believe in the names within the portfolio, and look at the investments made from a long-term perspective. And this results in holding a high active share at the portfolio level, and not putting all of its eggs in one basket when it comes to the names that will drive performance in any one year. This unrelenting pursuit of unrecognised or under-appreciated change combined with an alternative approach to company valuation has led to a concentrated portfolio that significantly differentiates Hermes Europe ex-UK Equity from its peers.

KEY DIFFERENTIATORS

These are the views of Tim Crockford and may not necessarily represent views expressed or reflected in other Hermes communications. The value of investments may fluctuate. This does not constitute a solicitation or offer to buy or sell any related securities. Advertorial produced by Hermes Investment Management Limited.

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Gaztransport Et Technigaz, a French oil services stock and recent addition to the portfolio, manufactures containment systems for the shipping and storage of liquefied natural gas in cryogenic conditions.

ALTERNATIVE APPROACH

combining political, economic and social factors to produce at times worrying results. The development of nationalistic politics, low economic growth (versus US and Asia), the end of quantitative easing by the European Central Bank, Brexit, and the social upheaval of immigration are all causing investors to pause and sit on the side-lines.

o hear a European equity investment manager say that they wouldn’t buy the European market would make most of us wonder if they were trying to come

PINPOINTING POTENTIAL

BENEFITTING FROM CHANGE

INVESTED IN ENERGY

KEY DIFFERENTIATORS

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By Hermes Investment Management

Recognising unrecognised change

By Natixis Investment Managers

Four perspectives on global equity

By Hermes Investment Management

By Natixis Investment Managers

Recognising unrecognised change

Four perspectives on global equity

By Hermes Investment Management

Recognising unrecognised change

By Natixis Investment Managers

Four perspectives on global equity

Despite the return of volatility, there’s plenty of growth and value to be found across global equity markets by active managers. What’s more, compelling alternatives are available for those looking for a differential in their equity allocations. Darren Pilbeam, UK Head of Sales at Natixis Investment Managers, rounds-up the latest equity manager views from Natixis’ multi-affiliate platform

Four perspectives on global equity

In the US, equities have certainly enjoyed a rally since the beginning of 2019. A better-than-expected earnings season and almost $200 billion of buybacks by the end of April supported their advance. Those searching for value have therefore had to look elsewhere. Speaking on CNBC’s Closing Bell in April, David Herro, Portfolio Manager at Harris Associates, said that while valuations of US equities had seen a resurgence, it had not necessarily been the case across Europe. “There are still places where there is lots of undiscovered value,” said Herro. “Specifically, when you look at European equities, they have been held back by some of the macro issues that I would argue have held back their share prices, but we still see good value creation and, as a result, we still see good investable opportunities in European stocks. “Most of the big European companies are multinational, they have exposure to… emerging markets and the US, and especially when the euro is trading at such a low level… [this] translates back to more of an advantage for European equities that sell into dollar markets and have dollar revenues.” Those chasing value in European equities might want to take a look at Harris’ equity strategies. The patient, long-term approach of its portfolio managers enables them to appreciate when portfolio companies are undervalued and, therefore, select them when they are attractively priced – then wait for the market to recognise what they believe is the company’s true worth. It’s an approach that has been one of the hallmarks of Harris’ success since its inception in 1976.

THE HUNT FOR VALUE

For other investors, who are still seeking the best growth strategies, it’s worth bearing in mind that it takes patience – as well as focus and insight – to generate alpha in US equities. After all, finding growth in one of the most efficient and over-researched markets in the world is no easy challenge. A differentiated, insight-driven approach to active management can make all the difference – as Hollie Briggs, product manager for the Growth Equity Strategies team at Loomis, Sayles & Company, highlighted in a series of interviews with us late last year. Briggs explained why it takes time to research a stock and how portfolio holdings in Loomis Sayles Growth Equity Strategies are differentiated from the pack. She revealed why, for instance, Amazon has been a portfolio holding since the strategy’s inception in 2006 – and why few active managers have held Amazon in their equity portfolios for as long. The key differentiator of Briggs’ team’s approach is the research process – even though everyone in the industry essentially has access to the same information. “It’s our focus and the quality of our decision-making process that leads us to different insights,” said Briggs. “That’s how we are able to generate different outcomes with the same information.” With a long research horizon and multi-year holding periods, it’s an approach that’s often been likened to private equity. “We say we adopt a long-term, private equity-like approach to investing because we are essentially investing in businesses as partners”, explained Briggs. “We’re not simply trading stocks – we’re not trying to capture alpha by near-term price action. Rather, we want to find high-quality businesses with sustainable long-term structural growth drivers, and then we wait. “We wait until short-term investors overreact, drive the price down and give us a buying opportunity – as long as our investment thesis remains intact. We are very patient investors, waiting for the right price.” Incidentally, Loomis Sayles’ Global Growth Equity fund passed its three-year anniversary on 8 June 2019. This differentiated global growth strategy is managed by Aziz Hamzaogullari and it reflects his team’s distinctive low turnover, high-conviction approach to active investment management with low factor risk exposure—a strategy carefully crafted to promote strong risk-adjusted returns.

GOING FOR GROWTH

There will, of course, be plenty of investors who find it difficult to ignore how ongoing US-China trade tensions may impact global markets in the months ahead. Should we see a return to the market volatility experienced in Q4 of 2018, navigating the turbulence might call for some alternative perspectives on the traditional equity portfolio. The good news is there are equity strategies that are designed to deal with volatility. In January, speaking at an exclusive wealth manager event in Lugano, Switzerland, Jean-Jacques Duhot, Chief Investment Officer, CEO and Managing Partner at Arctic Blue Capital, revealed how he got the idea for his systematic equity strategy, Arctic Blue Atlanterra. “I spent many years managing a group of discretionary traders, taking notes about their behaviour, noticing when they were patient, when they were opportunistic; why they were contrarian,” said Duhot. “And I thought, what if we could extract the best of these trading rules and turn them into code? In this way, we can overcome the natural biases and flaws of human traders and only trade when the market environment is favourable. ”Systematic equity strategies seek to capture periods of rising volatility and use the directional momentum to create opportunities for positive returns. Arctic Blue Atlanterra takes a contrarian bias, identifying when a trend begins to weaken and gradually initiating positions in the opposite direction – before the trend reverses. “We’re overweight on the contrarian model because we want to get a low correlation to the momentum riders and instead provide a high relative return,” Duhot continued. “It allows us to provide that high reactivity at major turning points in the market. Essentially, you need to have a different type of offering to de-correlate yourself from your peers.”

SEEING NEW HORIZONS

Whatever your time horizons, it’s good to have several different allocation perspectives for your equity portfolio. The ongoing uncertainty around European growth and the continuing US/China trade war – not to mention Brexit and US debt ceiling discussions – means the second half of 2019 is likely to provide a bumpy ride for equity investors. The bull-run of the past ten years may have buoyed a lot of boats. Yet, with the post-Christmas equity rally now behind us, a different and more volatile environment could expose the cracks in the hulls of some, and we might very well see a resurgence in the demand for active management. After all, an investment style that can find those companies that outperform the market – when it’s not all going in one direction – with be harder to find. Moreover, active managers can react directly to pricing pressures related to fundamentals and valuation on stock prices. It seems prudent, therefore, to pursue both growth and value equity strategies, and to seek to take advantage of both short-term market volatility as well as the longer-term secular growth opportunities. More often than not, balanced, flexible portfolios will be well positioned for whatever shifts and surprises lie ahead.

THE BALANCED PORTFOLIO

increased the downside risks. That’s the outlook for capital markets according to Esty Dwek, Head of Global Market Strategy for Dynamic Solutions at Natixis Investment Managers. “Equity markets have sold off since the re-escalation of the trade war, as expected,” said Dwek. “While the growth outlook remains ok, downside risks have risen. At the same time, earnings in the US have beaten expectations, bringing some underlying fundamental support to markets. “For now, markets remain jittery but still seem to be pricing in a US/China agreement, so short-term corrections on more negative headlines are likely. Over the medium-term though, barring a total breakdown in the trade talks, we expect risk assets to continue to grind higher, supported by an accommodative central bank and solid growth and earnings.”

or most of 2019 thus far, the macroeconomic view has surveyed green shoots appearing in the global economy. And while a stabilisation in growth is expected over the coming quarters, it should come as no surprise that the escalation of the US/China trade war in the past few weeks has certainly

NO GROWTH WITHOUT WATER:

• • •

Global macro builds portfolios around predictions of large-scale events on the individual country, region or global scale. They implement opportunistic investment strategies to capitalise on macroeconomic and geopolitical trends. Long-short strategies, as the name implies, can take long (buying a holding) or short (borrowing a stock you don’t own and selling it in the hope of repurchasing it at a lower price before returning to the stock lender) positions in multiple asset classes. The ratio of holdings to each one is based on their macro-economic projections. Managed futures strategies make use of leverage and implement price-based and trend-following algorithms to deliver enhanced returns in both rising and falling markets.

Yet, for those who are keen to tap into the more modish styles of equity investing, ‘thematics’ is clearly the word on the lips of many investors at the moment. Automation and technological improvements brought about by AI and robotics, for example, are changing in new and unforeseen ways how we live, interact and do business. This is occurring through the combination of significant advancements in performance capabilities and rapidly declining costs in key enabling technologies. Likewise, the technology rapidly changing our world also creates new risks to the safety of individuals, communities, industries and nation states. As new threats emerge to this basic need, new steps will be taken to mitigate them. That creates a huge opportunity to invest in those market participants that will be on the forefront of the changes in safety. Consider, too, the investment opportunities around water – water is a basic need, not only for human life, but also for economic development. It is a limited resource with growing demands placed upon its provision to sustain demographic and economic growth. With the increasing need to treat or transport water where it is required, and collect it when used to avoid cross contamination, demand is increasing for the provision of technologies and services to deliver the required quantity and quality of water. At a Natixis Investment Forum in Paris this March, Simon Gottelier, co-manager of the Thematics Water strategy, outlined the diversified and differentiated investment opportunity presented by ever-growing water service and technology industry. “A key reason why water is such a great investment opportunity is that it has perhaps the longest-term secular growth themes underpinning it,” said Gottelier. “Each of these long-term secular growth drivers are, by their very nature, fifty to a hundred-year narratives.

A THEMATIC APPROACH

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SECTOR REVIEW

EUROPEAN EQUITIES

Four perspectives on global equity

Recognising unrecognised change

Four perspectives on global equity

Recognising unrecognised change

attractive risk-return profiles to working hard as a kind of insurance policy. Today many investors have recognised that a sizable allocation to alternatives can give a needed boost to portfolios. AJ Somal, a financial adviser at Aurora Financial Planning, says that among this clients: “There has been a shift to investing in alternative assets, and a move away from traditional asset classes like bonds and equities.” He adds: “My clients have been investing in property (buy-to-let), peer-to-peer lending, and buying premium bonds – with the latter to mitigate tax.” The alternative funds chosen for a portfolio depend on the role they are expected to play and how granular a portfolio manager’s fund selection and asset allocation are. Do they sit in an ‘alternatives’ allocation? Are they included under a ‘diversification’ heading? If they are more directional, do they actually sit in a portfolio’s equity risk budget?

or most of 2019 thus far, the macroeconomic view has surveyed green shoots appearing in the global economy. And while a stabilisation in

NO GROWTH WITHOUT WATER:

SECTOR REVIEW

EUROPEAN EQUITIES

GOING FOR GROWTH

“There are still places where there is lots of undiscovered value... we still see good investable opportunities in European stocks”

THE BALANCED PORTFOLIO

"There is a 100% correlation between water availability and a country’s ability to grow its GDP,” according to Simon Gottelier.

Consider, too, the investment opportunities around water – water is a basic need, not only for human life, but also for economic development. It is a limited resource with growing demands placed upon its provision to sustain demographic and economic growth. With the increasing need to treat or transport water where it is required, and collect it when used to avoid cross contamination, demand is increasing for the provision of technologies and services to deliver the required quantity and quality of water. At a Natixis Investment Forum in Paris this March, Simon Gottelier, co-manager of the Thematics Water strategy, outlined the diversified and differentiated investment opportunity presented by ever-growing water service and technology industry. “A key reason why water is such a great investment opportunity is that it has perhaps the longest-term secular growth themes underpinning it,” said Gottelier. “Each of these long-term secular growth drivers are, by their very nature, fifty to a hundred-year narratives. Changing demographics in emerging economies, characterised by the shift from rural to urban areas, is placing a huge amount of strain on existing infrastructure which drives the need for fresh government investment. Gottelier continued: “The whole water opportunity is driven essentially by imbalances in supply and demand, so governments are spending more money on the oversight

of water quality – whether that’s for drinking water utilities or industrial water. And that also tends to be mandated spend, very predictable. “Furthermore, there is a 100% correlation between water availability and a country’s ability to grow its GDP. Without water, there can be no economic activity – none whatsoever.”

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“There are still places where there is lots of undiscovered value... we still see good investable opportunities in European stocks”

Loomis Sayles’ Global Growth Equity fund passed its three-year anniversary on 8 June 2019

"There is a 100% correlation between water availability and a country’s ability to grow its GDP,” according to Simon Gottelier.

Changing demographics in emerging economies, characterised by the shift from rural to urban areas, is placing a huge amount of strain on existing infrastructure which drives the need for fresh government investment. Gottelier continued: “The whole water opportunity is driven essentially by imbalances in supply and demand, so governments are spending more money on the oversight of water quality – whether that’s for drinking water utilities or industrial water. And that also tends to be mandated spend, very predictable. “Furthermore, there is a 100% correlation between water availability and a country’s ability to grow its GDP. Without water, there can be no economic activity – none whatsoever.”

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By Hermes Investment Management

By Natixis Investment Managers

Recognising unrecognised change

Four perspectives on global equity

By Hermes Investment Management

Recognising unrecognised change

By Natixis Investment Managers

Four perspectives on global equity

Home

By Hermes Investment Management

Recognising unrecognised change

By Natixis Investment Managers

Four perspectives on global equity