Quarterly Review M&G Pan European Dividend Fund Third quarter 2016 Fund manager Phil Cliff Overview The fund delivered a positive return during the third quarter and outperformed the MSCI Europe Index, led by Micro Focus and Covestro. During a quarter when defensive stocks were out of favour, Novartis (healthcare) and BAT (tobacco) struggled to keep up with a rising market. We concentrated the portfolio to 36 stocks following the sale of Aviva, Actelion and BP. Dividend growth continues to be robust across the portfolio, with Micro Focus and Dunelm raising their dividends by more than 15%. Performance, attribution & positioning
Fund performance and portfolio positioning The fund delivered a positive return during the third quarter and outperformed the MSCI Europe Index; positive contributions came from a variety of stocks. Micro Focus topped the list of contributors as the UKlisted infrastructure software company continued to deliver on a successful acquisition strategy. The purchase of Hewlett Packard Enterprise s (HPE) software business, announced in September, was well received by the market and Micro Focus shares ended the quarter 36% higher in sterling. The latest transaction provides scale in a defensive industry with high recurring revenues and strong cash generation, and there is considerable scope to improve profitability. We remain confident about the company s long-term prospects.
Covestro, the German chemicals business spun off by Bayer, continued its excellent start as a standalone entity. The company raised its outlook for 2016 in late July and the shares returned more than 30% in euros during the quarter. The stock has almost doubled since its IPO in October last year. Elsewhere, Prosafe in the energy sector added value after the Norwegian company successfully completed its refinancing. Nordea and Intesa Sanpaolo, two of our holdings in the banking industry, delivered returns of more than 15% in euros during a quarter when financials outperformed. We reduced both holdings in September with the result that we are now underweight in banks. GVC, the UK-listed online gaming group, rose more than 30% in sterling during the quarter. The company said organic growth opportunities from the bwin.party acquisition were greater than expected and the management team is confident that results for 2016 will be at the upper end of market expectations. The stock is up 60% this year. Sector allocation added value as our lack of exposure to utilities and telecoms, combined with our underweight in consumer staples, proved beneficial in an environment where defensive characteristics were out of favour. However, the market s rotation away from perceived safety had an impact on our own defensive holdings. Novartis (healthcare) and British American Tobacco (tobacco) were among the detractors during the quarter after the stocks were broadly flat in a rising market. We continue to be comfortable with these holdings. Other stocks were weaker in response to company announcements. Novo Nordisk, the world leader in diabetes care and insulin products, was the biggest detractor during the quarter after the Danish company lowered its guidance for 2016. Essentra, the UKbased supplier of plastic, fibre and foam products, created more uncertainty with its guidance for a revenue decline, although we have confidence in the company s ability to generate strong free cashflow over the long term. We added to both holdings on weakness. Portfolio activity There were no new purchases during the quarter, but we sold three holdings. Aviva, the UK insurer, provided a source of cash for higher-conviction ideas, while Actelion, the Swiss pharmaceutical company, left the portfolio after performing well. Actelion shares returned 40% in Swiss francs from their initial purchase in March 2015. BP, the fund s only oil major, was sold after the shares rallied more than 20% in sterling this year. Although BP is best equipped among the European oil majors for an environment of lower oil prices, we have concerns about the sustainability of the dividend. We also reduced our holding in BAE Systems, the UK defence company, which has returned 28% in sterling since its initial purchase in September last year. The proceeds from these sales were recycled into existing holdings where we have greater conviction, including Sampo, Banca IFIS and DS Smith. As a result of these transactions, the number of holdings has dropped to 36, consistent with our aim of creating a concentrated portfolio of best ideas. The fund remains underweight in consumer staples and energy, the former because of stretched valuations and the latter because of scepticism towards the dividend-paying capacity of some of the oil majors. We are overweight in industrials and consumer discretionary, although many of our holdings in these sectors, in particular RELX, have defensive characteristics. From a country perspective, the fund is overweight in the Scandinavian markets of Finland, Sweden and Denmark an outcome of bottom-up stock selection and underweight in the larger markets of France, Switzerland and Germany. Year-to-date performance After outperforming strongly in 2015, the fund has experienced a more difficult time in 2016, driven by stock-specific issues with Essentra and Prosafe. Essentra has been the biggest detractor so far this year after the international supplier of plastic, fibre and foam products lowered expectations for 2016. The company s guidance has been disappointing, but we have confidence in its ability to generate strong free cashflow over the long term and we believe that the shares are materially undervalued. We added to the stock on weakness. Prosafe, the provider of accommodation rigs for the oil & gas industry, suffered as a result of spending cuts by its client base in an environment of a lower oil price. The Norwegian company completed its refinancing in September and we continue to monitor the situation. Elsewhere, the pressure on financials, which have lagged the market significantly this year, had a knockon effect on our own holdings in the sector. Intesa Sanpaolo and Banca IFIS were prominent among the detractors as uncertainties about non-performing loans in Italy provided a headwind. We remain
comfortable with the capital discipline and long-term growth prospects of both companies. Dividend announcements We continue to be encouraged by the dividend growth from the fund s holdings. Micro Focus, the UK-listed software company, raised its dividend for the financial year by 38% in US dollars. The dividend has increased 11 fold since the company s IPO in 2005 and the management is committed to a progressive dividend policy. Micro Focus also announced a special dividend to accompany the news of its acquisition of HPE Software. Dunelm, the UK s leading homewares retailer, boosted its full-year dividend by 17% in sterling, having paid a special dividend earlier in the year. Outlook We live in uncertain times, but we remain optimistic. Europe continues to offer excellent opportunities for dividend growth at the individual stock level, evidenced by the continued progress of the fund s underlying holdings. The importance of being selective cannot be emphasised strongly enough. We believe the cash-generative nature of the fund s underlying holdings, their ability to grow dividends and The interim reporting season gave rise to dividend increases from some of our other UK holdings, including Saga (23%), Jupiter Fund Management (13%) and Hiscox (6%). RELX, the media business which has listings in the UK and Netherlands, reported a 6% dividend increase in euros for the Amsterdamlisted shares we own. BAT accompanied a betterthan-expected set of interim results with a 4% dividend increase in sterling and BAE Systems raised its interim dividend by a relatively modest 2% in sterling. their attractive valuation in the stockmarket stand us in good stead for the future. The fund s premium yield, which we aim to grow over time, offers a favourable proposition for long-term investors, in our view, in an environment where interest rates are low and growth is scarce. Long-term performance Please note that the fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash.
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