When reading media coverage of Europe’s sluggish economic growth, investors need to make a distinction between European companies and the European economy and, indeed, its stock market.
Stephen Paice, co-manager of the £536m Baillie Gifford European Growth trust, said that this is because Europe’s stock market index is largely filled with many overly large, slow-growing companies.
However, this creates an opportunity for long-term investors: “As investors we are fortunate enough not to have to rely on the success of that overall market, whether it is the economy or the stock market.
“When we look at Europe, there's still obviously plenty of problems with economic growth, sclerotic policy decision making, and a stock market which is still far too full of old world, slow-growing bureaucratic companies.
“I think a lot of these will be facing a lot of disruption and for those who want to take that top-down view investing passively, I'd be very careful about doing that. Europe is probably one of the worst markets that you could possibly invest passively - that is taking a bet on the overall market.”
Indeed, over the last five years Europe has been the lowest performing market compared to the other major stock market indices.
Performance of European index versus other major markets
Source: FE Analytics
This however creates a big opportunity for “those that are genuinely long-term, bottom-up growth investors” in Paice’s view.
He believes it gives an edge to investors who are willing to invest in companies and portfolios that look very different to the index.
A core part of his and Baillie Gifford’s investment philosophy is to try and identify outliers.
“What I mean by outliers are European companies have a very good chance of at least doubling in value over a five-year period - hopefully much more than that,” Paice explained.
“We now have a much better appreciation and understanding that outperformance in investing comes from holding a relatively small number of these outliers.
“It's not about building portfolios of slightly better than average companies who managed to slightly outperform the market.”
The Baillie Gifford European Growth manager believes the fact there is a lot of emphasis on some of the higher profile technology companies in the US and Asia “ is exactly why investors should be looking at Europe”.
“There are loads of areas that are there to be exploited in terms of market inefficiencies and some genuinely brilliant companies to invest in,” he added.
When it comes to finding these ‘outlier’ companies in Europe, most of the value that they produce over the long run comes from a combination of sales growth and margin expansion.
“Those are the outputs you get by having large addressable markets to go into, by having these very unique corporate cultures, by having something different to offer customers,” he explained. “That's how these growth companies are going to create value.
“Where we look, historically at least, the areas that have produced more of these ‘big winners’ than any other, areas like industrials. Europe has some of the best industrials, these are B2B businesses which are less well known, they kind of tend to fly under the radar.”
One example of this is Swedish multinational engineering company Atlas Copco, which Baillie Gifford has owned in its European open-ended fund for over 36 years since the strategy started in 1985.
Share price performance of Atlas Copco over 5yrs
Source: Google Finance
“These are some of the most adaptable and innovative businesses out there,” he said. “Europe has got some of the best engineering and industrial companies in the planet.”
Beyond industrials, he highlighted luxury goods as another area where European companies excel.
He said: “Europe still has some of the best luxury brands and - while having been around for decades, in some cases hundreds of years - these are still companies that are able to adapt to this massive shift in consumer behaviour and digitalization that we’ve seen in the market.”
Another area which is becoming much more interesting in his view is technology. He is particularly interested in companies that have network effects – where the more users that are on the network, the more valuable the network becomes.
“There are numerous examples in other regions that are far more well-known, but at least in Europe we're starting to see some of these technology platforms come to the market over the last few years,” Paice said. “These are the companies I think that the investors should seriously have a look at.”
Spotify is one example of the type of technology company with a large digital platform and strong network effect that he referenced.
However, he also highlighted food delivery companies such as Just Eat Takeaway.com, Delivery Hero and HelloFresh.
“These are three of the best food delivery companies in the world - and they also now have the ambition to take that business model overseas,” he said. “These are companies which are really challenging to become global winners.”
He also highlighted Norwegian online classified businesses Schibsted and Adevinta.
“So everybody in the UK would know Rightmove, Auto Trader, some of the jobs platforms that we see - and these companies Schibsted and Adevinta collectively own probably the world's largest collection of online classifieds in countries like France, Spain, Brazil, and a lot of other emerging markets.”
Despite this, he said that these types of companies don't seem to get as many of the headlines as some of the other well-known global technology companies.
Performance of the trust over 5yrs
Source: FE Analytics
Over the last five years, Baillie Gifford European Growth has delivered a total return of 148.10 per cent, versus 83.79 per cent from the average IT Europe peer and 62.48 per cent from the FTSE Europe ex UK benchmark.
The trust is trading at a 2.6 per cent premium to net asset value (NAV) and currently yields 2.3 per cent. It is 6 per cent geared and has ongoing charges of 0.41 per cent.