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The unloved European equities that Fidelity’s Morse is banking on

12 February 2019

Fidelity European Values’ Sam Morse explains that after years of restructuring and investor animosity, some European banks are beginning to look very attractive.

By Rob Langston,

News editor, FE Trustnet

Investors scared off by the huge balance sheet problems that faced Europe’s banking sector following the global financial crisis could be missing out on one of the region’s most interesting stories, according to Fidelity International’s Samuel Morse.

Investors in European equities have learned to temper their expectations following a series of false dawns.

Morse, manager of the £900.6m Fidelity European Values investment trust, said that rather than trying to make predictions about market direction, he sticks by his bottom-up stock selection process.

“I’m not a great bull about the outlook for European economies: sluggish has been the order of the day for many years and I don’t really see that changing,” he said.

“I don’t necessarily think we’re going to fall off a cliff [either], but whenever growth slows in Europe, certainly some of the areas like Italy and Spain – what we call the peripheral economies – do tend to suffer more.

“So, my approach is not to concern myself with the outlook but try to find those companies in Europe or headquartered in Europe that are able to grow their dividends in a more difficult economic environment despite political and other problems.”

Morse said that companies able to grow their dividends consistently outperform their peers and “the quantum of outperformance is quite striking”.

He added: “I always stay fully invested whatever my personal views or outlook, I take the view that the people have put money into the fund and if they do that then it is my responsibility to invest the money rather than to stay on the sidelines.

“I do have a view on the outlook but I don’t let it dictate to what extent I’m holding cash in the portfolio – it might have some impact on what stocks I select in the portfolio.”

The manager added: “I’m quite a cautious chap, the beta on the portfolio is less than one and I do probably spend as much time analysing the downside risk on the stocks I’m invested in as I do on the upside potential.”

Performance of index in 2018

 

Source: FE Analytics

Caution might have been a good strategy last year: after a strong 2017, the MSCI Europe Excluding UK index fell by 9.87 per cent – in sterling terms – while the MSCI World fell by just 3.04 per cent, as the above chart shows.



However, while the recent fall in markets might present an interesting opportunity for some investors, bottom-up stockpicker Morse said there were still question marks over current valuations.

“If you look at post-global financial crisis, aggregate valuations are a bit off the top but still look pretty toppy with regard to recent history,” he explained.

“In addition, I’m a bit sceptical about the ‘E’ [earnings] in many parts of the market in that I think we are getting quite close to a cyclical high in terms of the economy.

“Some of the cheaper areas of the market like autos might be one that people point to. Yes, those companies appear attractive on lowly values on P/E [price-to-earnings] ratios of 5x but that all depends on the ‘E’ being sustainable. The devil’s in the detail, really.”

There is one area that the manager is finding some interesting opportunities, however, and is one which investors might find surprising given the manager’s cautious approach: banking.

Performance of sector over 10yrs

 

Source: FE Analytics

“Unlike a lot of investors, I haven’t written off the banks entirely,” he said. “I do own some because I think we have a new breed post the financial crisis.

“Regulators have been so stringent in terms of capital requirements and making sure they de-risk, I would say we have a harder, reasonably safer bank.”

Now, having de-risked, European banks have become utility stocks, said the Fidelity manager, generating reasonable returns and paying out attractive dividends.

“Some of these banks are really quite exceptional, if they are sustainable and can grow dividends from those levels they will make very attractive investments over the next three-to-five years,” he added.

Typically, the banks held by the Fidelity manager are described as “northern European, dull, safe retail banks”, such as Norway’s DNB and ABN AMRO in the Netherlands. He does, however, own “a bit of spice” in Italy’s Intesa Sanpaolo, which he said is currently paying a 10 per cent dividend.

There are some stocks in the sector that the manager does avoid such as those involved in investment banks or that derive a significant proportion of their business from that part of the market.



“Generally banks are very much out of favour,” said Morse. “I’m not a bull in the sense that I think interest rates are about to rise and they’ll start making lots of money on deposit, I just think now the risk/reward [gap] is closing and some of the banks are making decent returns on capital, paying out decent dividends and growing them.”

Given his approach to investing, the health of the European economy has become less important for the Fidelity European Values manager over the years, as the continent’s firms have branched out beyond their borders. And this has become increasingly reflected within the trust.

“The European market has become a bit like the UK and other markets around the world in that it’s becoming less about domestic Europe: I’m investing in European companies not really the economies,” said Morse. “Those European companies – like companies everywhere else – are becoming more multinational and more global.”

This can also bring challenges, as was seen last year as European markets were hit by a slowing Chinese economy – exacerbated somewhat by the US-China trade spat – as demand fell for some products and services.

Yet, over the longer term – with the manager focusing on a three- to five-year investment period – a more balanced Chinese economy should be good for European consumer goods companies

“Yes, it will grow at a slow rate, but that’s partly by design because they want to inverse the quality of that growth,” said Morse. “In a sense, the Chinese economy is pivoting somewhat from being infrastructure- and investment-led to being more consumption-led.

“I’m not particularly enamoured of names that have benefited from the very strong growth of the industrial side of China. I’m quite optimistic in the longer term in companies exposed to consumption growth.”

As such, the manager instead owns several in the trust already, including names such as cosmetics brand L’Oreal, food and drink company Nestlé, and luxury goods conglomerate LVMH.

 

Performance of trust vs benchmark & sector under Morse

  

Source: FE Analytics

Since Morse took over management of the trust in January 2011 it has made a total return of 130.28 per cent while the average IT Europe peer is up by 115.77 per cent and the benchmark FTSE World Europe ex UK index has returned 73.86 per cent.

The trust is 10 per cent geared and is currently trading at a 10 per cent discount to net asset value (NAV), according to data from the Association of Investment Companies (AIC). It has ongoing charges of 0.93 per cent and a yield of 2 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.