Andrew Parry, CEO of Hermes Sourcecap, set the backdrop by recounting the bad news coming out of Europe: Italy has slid back in recession, Germany is teetering on the edge of recession and preferring austerity as the path to growth, unemployment in France has increased for 37 consecutive months.
“There is a great deflation fear for Europe. Will Europe mirror Japan’s experience [of 25 years of economic stagnation]?
However, he said there were reasons to be optimistic. Quantitative easing is expected to come to an end in the US and UK, but the European Central Bank is expanding the balance sheet, starting a “QE lite” programme to supply liquidity to the system.
Spain is acting as a competitive force in Europe, showing other countries they cannot resist change. In the past 18 months, wages have been falling but so is unemployment, as exports rise.
“Everyone had written Spain off as a basket case. Now manufacturing is starting to relocate to Spain, which is on France’s doorstep, pressuring it to follow reform,” Parry said.
A headwind turned into a tailwind is the euro, he said.
“QE lite has reversed the euro, which is good for exports and Europe remains an exporter. Eurozone growth of 1-1.5% next year will be plenty to change the mood.”
“It’s a great opportunity to find good companies growing at attractive valuation.”
Healthcare specifically is his big bet this year because of the implications of new technology. Sequencing the human genome, for example, is becoming a personalised service as costs fall.
“That is opening a whole new world of drug delivery discovery. Medicine will actually be curing illness not treating symptoms.
“The healthcare industry is going through profound change but companies are trading at the same multiples as other industries. There’s been a 15-year de-rating and people got anchored to the past view of healthcare.”
Value Investing
Healthcare was a recurring theme among the presenters. Kotaro Miyata, investment specialist, M&G Global Dividend fund, said he was overweight healthcare and agreed that the industry had longterm attractions and positive valuations.
Miyata’s theme was value investing, which he defined as buying cheap stocks in the belief that over time they will revert.
“Value investing works because of the perception of risk. There is a natural aversion for falling share prices, but in many cases it’s just sentiment. That leads to bad investment decisions.
“With value investing you take advantage of shorterm-ism. A lot of market participants don’t have the stomach for shorterm [volatility].”
He sees opportunities in the US and Europe. “In the dispersion between the cheapest and most expensive quartile in Europe, the cheapest quartile has been trading low for a long time.”
In the US, growth stocks on the Russell 1000 index are at their most attractive level in long time, he added.
In addition to healthcare, he likes construction stories, oil and gas, consumer discretionary, technology companies in hardware as opposed to software, which he believes is expensive.
One pitfall of value investing is volatility. He address that by screening for the cheapest quartile by sector rather than the market as whole.
Another risk is value traps. “Some stocks are cheap for a reason, and we look for any barriers to making money.”
“Our approach is to focus on price-to-book. We believe asset values are more stable than earnings.”
Playing Europe’s inefficiencies
Gaps between earnings consensus numbers and what the companies are actually saying about earnings are one way Stefano Girola, portfolio manager at Syz Asset Management, finds investment ideas in Western Europe.
“Earnings direction is a powerful leading indicator of where the price of an equity is going,” Girola said.
Stock prices are summarised by consensus estimates. However, after 2008, most analysts became more cautious with their equities research, he explained.
“That means the quality of consensus earnings are much lower and that helps us find value.”
“Crucially, we speak to the company, and not always the CEO or top management. We speak to number crunchers. Our meeting is not to understand ten year strategies, but top and bottom line growth for the current and next year and compare that with the earnings consensus.”
“We are not bottom fishing stocks. We need some consistency that shows price and earnings are moving in the same direction.”
In addition, the low growth economic environment in Western Europe helps reveal winners and losers more clearly. “We can see those companies that can expand margins despite no economic growth, and those suffering without strong GDP growth.”
He is slightly negative on Western Europe. Consensus estimates for the earnings per share for companies on the Europe 600 index are 13% for 2015. He believes the number could actually be in the low single digits.
“We continually speak to companies to have fresh views on where numbers are going and everytime we speak to them, 70% of the time we have to cut our earnings expectations.”
Diversified real estate
Many investors believe owning a home or property in the home country is sufficient exposure to the real estate asset class, said Barry MacLennan, real estate investment specialist, Standard Life Investments.
But alpha comes from a “blended approach”, investing selectively in developed markets through direct and listed exposure to help manage volatility.
Over the last couple years, the appetite has grown for listed real estate because it preserves a measure of liquidity for clients with shifting asset allocation needs, he said.
He blends listed assets with direct into one diversified portfolio.
“Listed markets act as a fantastic lead into direct markets, which play catch up with listed counterparts.”
Moreover, MacLellan is making selective bets across developed markets. He’s bullish on Tokyo offices, which have near term strong outperformance and he will be looking at logistics facilities as Japan’s economy improves.
In the mid-term, he likes Manhattan office space and has made selective bets in the central business districts of Barcelona and Madrid.
“The low yield environment is helpful. Bond yields are under pressure, and that creates a more positive yield margin for property versus fixed income other sources.
“For income investors unable to find the yields in fixed income markets, the real estate asset class is proving attractive.”
