Since restructuring the portfolio at the beginning of the year the Dublin domiciled New Star European Growth Fund, lead managed by Richard Pease, outperformed both its benchmark and sector over the five months to 30 May 2008*. The fund, which is AAA rated by Standard & Poor’s†, returned 2.06% in the month to end May versus 1.49% from the FTSE World Europe ex UK Total Return Index*. Below Richard details the opportunities he sees in stocks with earning streams less reliant on global economic conditions.
Stockmarkets in Europe excluding the UK endured challenging conditions from the summer of 2007 to early 2008, with investors retreating from companies in so-called cyclical sectors regardless of the quality and stickiness of their earnings. Encouragingly, investors appear to have become more discerning in recent months, with companies again being judged on their individual merits.
The valuations of many stocks, particularly medium-sized growth companies, have fallen significantly over the past year and it is probable that much of the negative economic outlook is already reflected in market prices. While company statements have become more circumspect, the message being conveyed by managements is cautiously optimistic. Indeed many are now buying stock for themselves as well as for cancellation.
Corporate Europe is not over-geared and the health of the consumer compares favourably to the US. Earnings results so far in 2008 indicate that Continental European companies outside the financial sector are doing reasonably well. This is reflected in many of the companies being considered for investment by the New Star European Growth Fund having underlying free cash flow yields approaching 10%. It would appear that the rocky first quarter has thrown up an attractive longer-term opportunity for selective buying.
It is, however, likely to be far from plain sailing over the summer months, with headwinds predominantly coming from the West. Deteriorating statistics confirm that the risk remains of a significant US slowdown or recession. Investors are nervous about the likely length and severity of this slowdown and are uncertain about how it will affect growth trends in Europe and in emerging markets. Markets are, therefore, likely to be unsettled until prospects for the US economy become clearer.
Rising inflationary pressures resulting from higher commodity prices and wage increases are an additional complication. The US central bank has eased monetary policy aggressively; by contrast, the European Central Bank may be more reluctant to cut its repo rate and the resultant strength in the Euro may cause competitive problems for European exporters.
In such circumstances, the New Star European Growth Fund is focusing on companies with strong pricing power in consolidated sectors. It has been avoiding businesses that depend on discretionary spending and has been underweight in telecommunications, pharmaceuticals and utilities. The fund's exposure to financial stocks has also been reduced with uncertainty remaining over asset impairments and profitability due to the difficulty of obtaining funding. It therefore seems prudent to seek attractively priced companies in sectors outside financial services for the time being.
Robust companies that have relatively stable earnings and that trade on undemanding valuations remain the favoured hunting ground. A recent addition to the portfolio is Fugro, the global leader in offshore geotechnical and survey services. This company is building up a bigger share in marine seismic and is well placed to benefit as companies and governments seek to tap fossil fuels from increasingly challenging environments. Another purchase was Autogrill, the world's biggest provider of food, beverage and retail services for travellers. The company should benefit from the integration of several acquisitions together with the secular growth in international travel.
Moving into the summer months, the fund will continue to avoid cyclical stocks, preferring to concentrate on companies that operate in niche markets and are capable of growing regardless of the wider economic picture. Such businesses should prove resilient if the economic climate takes a turn for the worse and, importantly, have the potential to bounce sharply when wider investor sentiment improves.
Past performance is not necessarily a guide to future performance. The opinions expressed here represent the views of the fund manager at the time of writing and should not be interpreted as investment advice.
*Performance at 30 May 2008. Data source: Lipper. All rights reserved, base currency Euros, gross income reinvested. For performance purposes the New Star European Growth Fund is measured against the FTSE World Europe ex-UK Total Return Index and is in the IMA Europe excluding UK sector.
†Rating at 30 April 2007.