Feb 13 2012

Are European woes bringing investment opportunity?

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This presents an ideal situation for European special situations funds, as the term carries connotations of looking beyond the usual suspects and being willing to invest in companies undergoing a turnaround or some other change that the market has failed to value properly.

As a result these types of funds usually perform well in a market boom and recovery, but badly when the market troughs.

It is no surprise that in the 12 months to January 30 2009, which includes the Lehman Brothers crash of September 2008, European special situations and recovery funds made an average loss of 25.1 per cent.

However, in the 12-month period following that, to January 30 2010, they bounced back making an average gain of 27.7 per cent, according to Morningstar.

It may therefore be coincidental, or intentional that half of the four European special situations or, recovery vehicles were launched in late 2008 and early 2009, in the recuperation period. These were the Henderson European Special Situations and the Scottish Widows European Special Situations funds.

In the period since the newest fund in the sector, the Henderson European Special Situations, launched on October 1 2009, to February 3 2012, it has outperformed its peers – producing a cumulative return of 17.73 per cent, compared with the Jupiter European Special Situations, the Scottish Widows European Special Situations and the JP Morgan European Recovery funds, which have posted a 5 per cent gain and losses of 4.9 per cent and 5.07 per cent respectively, according to FE Analytics.

However, the crisis of 2008 is far different to the one in Europe today. The one in 2008 was purely a banking crisis, whereas current developments intertwine banks and sovereign debt, meaning that the next recovery could adopt a different shape and take longer to achieve.

So far, in the year to January 30 2012, all of the four funds that are categorised European Special Situations vehicles by Morningstar made an average loss of more than 10 per cent.

Chris Clarke, manager of the £314.4m Scottish Widows (HIFML) European Special Situations fund, admits that the past few months have been full of twists and turns. Even Germany, the eurozone’s largest and strongest economy, has experienced occasional wobbles. Its auction of 10-year bunds on November 23 was the worst German bond sale since the euro’s inception.

Following the news, the fund, which has a 16.5 per cent weighting in the region, suffered, with its returns dropping by 2 percentage points overnight, reaching a three-month low of a 6.56 per cent loss on November 25 2011.

Prior to the August stockmarket crash, the fund was having a good year, but a drop in sentiment caused its returns to nose-dive on August 1 2011, and as a result, in the year to February 3 2012, it has made a cumulative loss of 8 per cent.

According to Julian Fosh and Anthony Cross, managers at Liontrust, the key to avoiding this type of problem is diversifying portfolios and having exposure to European companies that export to other parts of the world where growth remains.

Mr Fosh says: “It’s an interesting feature how well European companies have held up. We’ve generally done quite well in Europe. Nothing has fallen off a cliff – maybe some companies have been a little bit softer, but generally it’s been fine. Most areas have been quite strong. This is because quite a lot of our companies are selling into Europe, but then Europe itself is selling internationally.”

The managers say that current market conditions are perfect for small-cap stocks, as the added value you get from small caps is often overlooked by the market and you can “get very nice share price performance, a rerating affect”.

The managers remain bearish on domestic-facing consumer and retail stocks. “Overall we believe there’s a large overhang of debt. It’s going to be a strong grind out for companies that are exposed to consumer demand,” says Mr Cross. However, even in the case of consumer-facing stocks, the managers say investments with unique businesses and commercial positions should do well.

Charles Payne, investment director at Fidelity, agrees that this is the way special situation fund managers should look at current market conditions. “A true special situations investor will look for stocks which have unique characteristics and issues which set them apart not just from other sectors, but also similar stocks in the same sector.

“At a more macro level, a special situations investor will tend to be drawn more to those areas of the markets which are underowned by institutional investors in general and which are relatively cheap compared to their own long-term valuation history.”

Although a resolution to Europe’s problems is still forthcoming, Richard Pease, manager of the Henderson European Special Situations fund, claims there have been some positive signs from the market. He says: “The market has taken comfort from the European Central Bank’s (ECB) decision to cut rates and to provide liquidity support to banks via a long-term refinancing operation, which was taken up enthusiastically. Elsewhere, the Chinese authorities are attempting ensure a soft economic landing with an easing of banks’ reserve requirements.”

The manager is hopeful that, in spite of the depressed levels of growth and a lack of stability in the eurozone, his portfolio “has the potential to perform strongly if the uncertainties surrounding the currency environment are addressed”.

Mr Cross adds: “We’re hearing from our companies that certain parts of the world growth remains positive and there’s still a certain pull-through in demand. Specialist exporting areas will do well.”

However, he argues that fund performance will boil down to an individual fund manager’s investment style.

“Not all managers have the same style, some go for value and some go for growth and that makes it difficult to compare funds. Some will do better than others,” he says.

Simona Stankovska is features writer at Investment Adviser