M&G European Smaller Companies Fund Review: Third quarter, 2012

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1 M&G European Smaller Companies Fund Review: Third quarter, 2012 Overview Fund manager Charles Anniss The third quarter of 2012 witnessed turbulent, though generally rising, markets, ending positively for shares in smaller European companies. The M&G European Smaller Companies Fund delivered strong returns against both the HSBC Europe Smaller Companies Index and the peer group, with good stockpicking as the primary source of outperformance. Fund manager Charles Anniss took advantage of attractive valuations to add three new holdings to the fund, while conversely closing three positions. Fund performance Sterling performance Sterling A (UK database) M&G European Smaller Companies Fund HSBC Smaller European Companies Index IMA European Smaller Cos sector average 3 months % 6 months % 1 year % 3 years % pa 5 years % pa Since tenure* % pa Fund quartile ranking in sector Source: Morningstar, Inc., IMA European Smaller Cos sector, UK database, as at 30 September Sterling A class shares, net income reinvested, price to price. *Charles Anniss took over management of the fund on 29 December 2006 The third quarter of 2012 witnessed turbulent, though generally rising, markets, ending positively for shares in smaller European companies. The period saw fear and risk aversion giving ground to more upbeat investor sentiment, with European policy moves and central bank interventions as the primary drivers of improved confidence. While European equities finished the quarter up, the beginning of the period was marred by a general sense of investor malaise, as lacklustre economic data and continuing uncertainty in the eurozone, particularly concerning Spain, dampened spirits. The mood then began to change, with a strong rally taking hold at the end of July in anticipation of European Central Bank (ECB) action to tackle the ongoing eurozone debt crisis. This generally positive climate prevailed into August, after ECB president Mario Draghi announced he would do whatever it takes to safeguard the future of the euro, further lending to the ebullient atmosphere. As risk appetite returned, more cyclical sectors came back into favour, and investment interest re-focused on Europe where, in particular, financials and lower quality companies outperformed against higher quality names. Moving into September, markets were further enlivened by central bank moves across the world. The ECB offered to purchase eurozone countries short-term debt in unlimited amounts, allowing pressure to be eased

2 on peripheral bond yields, while in the US, the Federal Reserve confirmed its third tranche of quantitative easing. Meanwhile in Asia, the Bank of Japan launched its own aggressive stimulus programme, and the Chinese government announced a huge infrastructure spending plan to boost sluggish growth. This saw the previously lagging materials sector return to favour, as confidence picked up over the likely impact that rejuvenated Chinese consumption would have on demand for raw materials. In this environment, the M&G European Smaller Companies Fund delivered strong returns against both the HSBC Europe Smaller Companies Index and the peer group, with good stockpicking as the primary source of outperformance. Largest positive contributors Stock Relative weight Performance Absolute return % (start of period) % contribution % Sportingbet United Drug Schoeller-Bleckmann Source: Xamin, investment returns (gross of fees) calculated in sterling, as at 30 September Performance contribution relative to HSBC Europe Smaller Companies Index. The fund s best performer for the quarter was online gambling company Sportingbet. Sportingbet's share price experienced a strong run on the back of speculation that UK bookmaker and online betting firm GVC would be making a joint bid for the business. The firm s management team subsequently rejected an offer in October (outside the period under review), a decision with which fund manager Charles Anniss agreed, as he believes the offer undervalued the business. He has maintained his holding in the company and remains supportive of the management s strategy, developed over the past several years. Another major contributor to returns, leading international healthcare services company United Drug has produced very healthy results throughout the year, with its US business in particular performing very strongly, highlighting the international nature of the firm. United s share price also benefited from the announcement that it was moving its primary listing from Ireland to the UK, as this increased visibility attracted considerable positive investor attention. Charles feels that the company s underlying fundamentals and strong return on capital are now being recognised by the market, and he remains confident about the company s prospects going forward. Schoeller-Bleckmann Oilfield Equipment, the Austria-based maker of directional drilling equipment, also performed well for the fund. The company is benefiting from improving pricing power and margin progression, and has continued to reap rewards from the growing demand for its high-precision products, with strong growth particularly stemming from the developing markets. Largest negative contributors Stock Relative weight Performance Absolute return % (start of period) % contribution % Temenos Hugo Boss Club Mediterranee Source: Xamin, investment returns (gross of fees) calculated in sterling, as at 30 September Performance contribution relative to HSBC Europe Smaller Companies Index. The largest detractor from returns was Swiss banking software systems producer Temenos. The company s share price suffered on news that its recently appointed chief executive was departing, accompanying a profit warning related to banking customers reluctance to spend money on their IT systems. In light of the ongoing difficulties with the company, Charles fully closed his position during the quarter. He felt that Temenos had 2

3 been a challenging investment, and although its shares were not expensively valued, he had lost conviction in the corporate strategy, especially given the recent managerial changes. German luxury clothing retailer Hugo Boss also held back performance, with its share price affected by concerns over top-line growth in emerging markets, as this was slightly subdued relative to expectations. However, Charles believes that Boss s long-term dynamics remain sound, with ongoing store roll-outs and improvements in its US wholesale and Asian retail operations continuing apace. In addition Club Mediterranee, the upscale holiday village operator, underperformed. While the group has been diversifying its customer base internationally, with expansion into developing regions and China, it is nevertheless exposed to the anticipated decline in European leisure expenditure. Indeed, mid to high-end holiday spending has suffered amid concerns over the economy, and investors reacted negatively to Club Med s reported slowdown in bookings for the summer months. Fund management Portfolio activity Charles added three new holdings over the quarter, starting with Piaggio, one of the world s leading producers of two-wheel scooters and motorbikes. The group s excellent brands, strong distribution network and innovative technology make it very difficult to compete with, while increasing penetration in the emerging markets should allow it to continue to grow this part of its business. He also purchased shares in UK property company Shaftesbury. He feels that the business has some of the best quality assets in the world, and over the past 15 years has created a number of mini villages in London s West End, where international retailers are keen to be located. Charles believes that Shaftesbury not only possesses the skills of a high-quality property company, but also the mind-set of a retailer, which allows it to enhance value. Finally he initiated a position in Veripos, a Norwegian firm that is a leading player in the provision of highprecision positioning systems for the offshore oil and gas industry. Veripos is one of three companies in the world capable of supplying the systems necessary to allow accuracy of operations in extreme environments, and has been increasingly taking market share. The group has invested heavily in its global network of positioning sub-stations, and has gradually been shifting to higher-quality-end customer solutions, particularly around oil drilling, which is a strong growth driver for the company. Conversely Charles closed three of the fund s positions during the quarter. As mentioned above, he sold his shares in Temenos, as well as those of Turkish auto parts maker Tofas and Russian bank Nomos. Tofas had performed strongly for the fund, and Charles closed the position to raise cash for the purchase of Piaggio, while tailoring his exposure to the automotive sector. In terms of Nomos, the bank s share price improved in light of a potential bid from rival bank Otkritie, and this created a good opportunity to exit the holding. Charles also managed positions which have performed particularly strongly for the fund, trimming holdings including Danish food ingredients maker Christian Hansen, food, pharmaceutical and environmental testing business Eurofins Scientific and Austria-based machine manufacturer Andritz, which produces hydroelectric power plants and pulp mills. 3

4 Country allocation Country Fund % HSBC Smaller European Companies Index % Relative % Germany UK France Ireland Austria Sweden Denmark Belgium Other Cash Source: M&G, as at 30 September 2012 Charles is very much a bottom-up stock picker, and country weightings result from his ability to find attractive investment opportunities. Germany and Austria, for example, offer a wealth of world class businesses that are leaders in their particular fields. Conversely, the fund has minimal exposure to Southern Europe where there is a high proportion of very domestically-focused businesses, and where the type of firms that Charles prefers high-returning, often internationally-focused companies tend to attract a significant valuation premium due to their scarcity. Sector allocation Industry Fund % HSBC Smaller European Companies Index % Relative % Consumer goods Oil & gas Healthcare Basic materials Utilities Telecommunications Technology Consumer services Industrials Financials Cash Source: M&G, as at 30 September 2012 Overall, the fund s sector positioning has not changed significantly in recent months, as Charles takes a longterm approach to investment, typically with a three-to-five year horizon when he invests in a new holding. Recent purchasing activity has seen him buying stocks slightly more sensitive to the economy and somewhat lower down on the market capitalisation spectrum, as this is where he is finding a greater abundance of highquality businesses at attractive valuations. The portfolio remains under-exposed to financials, as Charles thinks that regulatory pressures may continue to burden the sector for some time. He finds it difficult to find truly differentiated financials with high sustainable returns and scarce assets to protect their competitive position. 4

5 Beyond financials, the fund is broadly neutrally positioned from a sector perspective at present. One area that stands out is an overweight position in 'consumer goods' which is made up of a very heterogeneous collection of subsectors, ranging from automotive parts to beverages. Within the grouping, Charles owns a number of more defensive growth businesses such as food ingredients companies Christian Hansen and Glanbia, and smokeless tobacco company Swedish Match. Risk management Drivers of forecast portfolio risk (%) Source: Barra Risk Model relative to HSBC Smaller Companies as at end September 2012 Analysis from the Barra risk model highlights the key drivers of portfolio risk for the fund. The chart above shows that stock selection is a significant driver of risk in the portfolio, which is consistent with the fund manager s bottom-up approach. It is therefore expected that stock selection would be the key driver of returns over the long term. Most of the systematic risk within the portfolio is driven by style risk, which is an inherent bias of the investment approach. This is driven by the fund s underweight to value and preference for companies that have been able to sustain high returns and have strong growth opportunities. Country risk is a smaller contributor to the overall risk budget and is partly driven by the fund s underweight exposure to the UK and peripheral Europe and overweight position in Germany and Ireland. Sectors and currencies contribute only a small part to the fund s overall risk budget. 5

6 Outlook On the whole, the outlook for Europe is still uncertain. Although the third quarter saw an improvement in investor sentiment, for most of the year markets have been characterised by periods of extreme risk aversion, with newsflow and the macroeconomic situation driving investor behaviour and fundamentals largely overlooked. While this makes for a challenging environment, it also provides good opportunities for dedicated stock pickers to find compelling investments at attractive valuations. Charles believes the fund is very well placed to take advantage of an improvement in sentiment and a return to fundamentals, as it contains high returning, value creating, structural growth companies not currently valued to reflect these inherent qualities. As a long-term investor, he remains focused on the long-term value of the businesses in which he invests, and remains optimistic about their prospects going forward. Prices may fluctuate and you may not get back your original investment. For Financial Advisers only. Not for onward distribution. No other persons should rely on any information contained within. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No S1181 6