Fund Strategy
Odey Asset Management pursues an absolute return philosophy across its range of funds – following a compelling dogma, that a pound tomorrow should be worth more than a pound today.
A macro-economic viewpoint is an integral part in the management of Odey funds and the company conducts a monthly meeting between the fund managers, addressing the macro-economic environment as they see it.
Feras Al-Chalabi is responsible for the Odey Continental European Fund and the Odey European Allegra Fund – taking control of the former in 2005 after seven years experience analysing European equities. He is supported by a team of 13 analysts.
Although the fund follows a purely bottom up style, it combines this approach with a top down view taken from the company’s monthly macro-economic meeting.
Al-Chalabi seeks to map out an industry’s future, bearing in mind the context of its history, to analyse points at which capital is likely to be removed from or added to that industry.
This approach aids the fund manager in identifying changes or inflection points within an industry, with key criterion to identifying management, product line and regulatory change.
Once these changes are discovered, the fund manager looks for valuation support in the form of dividend and free cash-flow yields, and assesses these against risk before an investment decision is made.
Fund Holdings
The fund maintains a fairly concentrated portfolio and its top ten holdings constitute 34.3 per cent of total assets under management.
| Top 10 Holdings as at 28th November 2008 |
Per cent of fund (%) |
| CIBA HLDG AG | 5.8 |
| KONINKLIJKE KPN NV | 4.1 |
| SENIUM RETE GAS | 4.0 |
| MUNCHENER RUCKVERSICHERUNGS AG | 3.5 |
| KONINKLIJKE AHOLD NV | 3.0 |
| COLRUYT SA | 3.0 |
| ALLIANZ SE | 3.0 |
| ZURICH FINANCIAL SERVICES | 2.9 |
| SWEDISH MATCH AB | 2.5 |
| NOVO-NORDISK AS | 2.5 |
The economic cycle plays a pivotal role in fund holdings and in light of the current recessionary phase it's not surprising to see a fairly defensively positioned portfolio with prime investments in non-cyclical large caps – pharmaceuticals, healthcare and utility stocks therefore score high, whilst banks and manufacturers have a limited inclusion.
Nevertheless, Al-Chalabi has tentatively started to reduce weights in defensive stocks for cyclicals on the premise that the worst may soon be over for European equities.
He believes more specifically that telecoms may see a flight to quality, thus changes in the portfolio over recent months have resulted in new entries in stocks such as Deutsche Telecom.
The fund maintains an unconstrained style with no sector or stock limits on holdings apart from the IMA’s requisite 80 per cent allocation to European equities.
The average stock in the top 10 holdings, however, doesn’t exceed more than 3 per cent, and only on very rare occasions does the fund hold over 6 per cent - this approach is used to reduce stock specific risk.
When addressing regional weights, the fund supports Germany on the grounds that German GDP has overtaken Spanish for the first time since 1994. Cash holdings have reduced dramatically to 8.5 per cent from a high of 15.7 per cent last month with the cash used to up exposure to European equities, now standing at 91.5 per cent. Futures positions where also unwound this month from their 6 per cent inclusion last month, and are used for efficient portfolio management.
The fund is actively managed and maintains a high portfolio turnover, with the current investment climate forcing even more swift changes in holdings. It would not be unlikely to see many new entrants/exits in the funds top ten holdings month on month, there were six new entrants in November 2008 alone, and the fund manager’s allocations toward more cyclical stocks may become more pronounced as the European economy recovers.
There are also no plays on currency appreciations as exposure is held in relation to the regional composition of the fund – thus 79.9 per cent is held in the Euro and 15.1 per cent in the Swiss Franc.
Fund Performance
The fund has been a clear out-performer in the IMA Europe ex UK sector, having posted the best performance over three month, one year, three year and ten year horizons – thus both short-term and long-term investors in this space would have prospered on the back of this fund.
Although the fund hasn’t produced a gain over this year, it’s noteworthy on a comparative basis having preserved capital with a one year return of -0.5 per cent compared to the average fund in the sector losing 24.2 per cent – no surprise to see it hold a triple Crown Rating then – the chart below highlights the fund’s sterling three year performance relative to its benchmarks.
Fund Risks
The fund manager employs a cross-correlation focus to ensure that overall portfolio risk remains low, which has resulted in the fund being the least volatile in the entire IMA Europe ex UK sector – reflected by a mild 13.2 per cent annual monthly volatility over the last three years against a sector average of 17.7 per cent.
Investors fortunate enough to have been invested in this fund not only would have had the best returns, but also the lowest risk – a combination highly sought after.
Risk is also reduced by analysing correlations between sectors, as the fund manager believes that a high degree of inter-correlation between sectors can exist – and by addressing this fact the fund has posted the lowest R-squared against the average fund in the sector.
The biggest fund risk pertains to its exposure to European equity markets – mandated to remain at least 80 per cent by the IMA – and given that MSCI Europe ex UK index plummeted by 42.3 per cent this year, it’s reassuring to see the fund posting a three year beta of 0.57 to this index – the lowest of any fund in the sector – consolidating the defensively positioned un-cyclical low risk stance.
Furthermore the fund posts the highest Sortino ratio of 0.42 over the period – meaning that the fund has performed well when taking into consideration downside risk.
Other risks the fund manager believes to be important are more stock specific risks and policy responses. For example the fund’s relatively underweight stance towards financial stocks could see performance suffer if financials rally, and if policy responses from European governments fail in fulfilling their objectives as financial practitioners expect, all European stocks will be hit.
Outlook
Odey Asset Management currently manages £2.4bn with an approach geared around preserving capital on the down and accentuating returns on the up – the Continental European fund has done exactly that, and is a shining example of an out-performer across all investment horizons having followed a low risk unconstrained style.
Feras Al-Chalabi believes that markets have become de-rated and that the authorities have begun to take corrective action after finally understanding the extent of the liquidity crisis. Al-Chalabi views equity markets as highly efficient at pricing in sentiment and thus have discounted a recession into valuations, hence stocks are now trading at artificially low levels.
Al-Chalabi has calculated that a 35 per cent drop in earnings has already been discounted into equities and that they are trading at a very low earnings multiple of 8.5x, a level not seen since 1982 – this cheap valuation prospect, coupled with corrective policy responses is what he feels offers attractive buying prospects right now in European equities.
Nevertheless Al-Chalabi maintains a defensive stance as he views the recession we are in as consumer led, which means it may last longer than some expect. Furthermore he views emerging market GDP to slow and that the requirement for European banks to tidy balance sheets will cause the availability of credit to remain strained.
The biggest driver of returns over the year has been the fund’s defensively positioned portfolio, coupled with an understanding of the macro-economic roadmap – this has meant that the fund manager switched into pharma stocks early at the expense of financials – which has aided performance greatly and an unconstrained actively managed style has allowed the fund manager to move swiftly between equity sectors to suit differing economic conditions.
Although the current stance is defensive, the fund manager does expect to gradually commit more capital as markets start to show signs of sustained health. As a means to gain tentative access to European equities, assuming one believes that we have approached the bottom of the economic cycle, Odey Continental European offers a proven track record of low risk and high return and on that basis stands out.
Financial Express Research Mean Variance Optimization Model Methodology
To find a suitable fund for this piece we created a mean-variance optimization model based on three year monthly data using the relevant IMA sector – A report on the IMA sector as a whole can bee seen if you click here.
The optimization model presents an efficient frontier on which a minimum variance portfolio is derived – effectively a portfolio of funds displaying the best risk-return combinations over a certain period.
The funds which feature most heavily in this portfolio are then added to a shortlist of funds within the relevant IMA sector. Those with the higher allocations, and are well positioned in view of current market turbulence, form the basis of our fund in focus.
The CF Odey Continental European fund has been prominent in our optimization model displaying an attractive risk-return combination. The fund was launched on 23rd April 1997, classified as an OEIC with an approximate size of £286m as at November 2008, and aims to achieve long-term capital appreciation through investing primarily in quoted securities issued by companies with principal offices in Continental Europe – For more fund details, the factsheet can be viewed by clicking here.
*Source of data: Financial Express Analytics