Strong European returns unlikely to continue, warns RECM
18 March 2014 | Investments | General | Wilhelm Hertzog, RECM
The tremendous rerating of European stocks during 2013 meant value investors such as RECM saw big moves in many of their core holdings. As a result they are now having to hunt in more obscure places to find cheap assets, and warn that returns from current levels are likely to be less than spectacular.
"Stocks in Europe offered extraordinary value over the past two years,” says Wilhelm Hertzog, one of the portfolio managers of RECM’s award-winning Global Fund. "Once investors began to realise that Europe wasn’t about to implode, stocks rerated tremendously.”
Hertzog explains that this rerating drove the Fund’s move out of several core holdings. "Shares like French retailer Carrefour, as well as Greece’s Titan Cement and Hellenic Exchanges, reacted strongly to the faintest glimmer of improved business conditions. One of our top sales during the last months of 2013 was Portuguese retailer Sonae, a share we only started acquiring late in 2012. That tells you something about the speed with which certain shares moved in Europe,” says Hertzog.
Despite these sales, the Fund continues to hold a larger exposure to Europe and Japan than the popular international benchmark indexes. "We consequently have a smaller exposure to the US. We also disagree with the market’s current high regard for industrial shares – we prefer stocks in the materials sector,” says Hertzog.
RECM focus on identifying high quality companies trading at a deep discount to their intrinsic value. While the company’s research team continues to unearth new ideas around the world, they’re finding that they have to look harder and in more obscure places to find cheap assets than was the case a year or two ago. They are still however finding some valuable opportunities in unpopular sectors.
He says that the largest purchase by far in the last six months has been Japanese oil and gas producer, Inpex. "Investors are shunning the oil and gas sector – they don’t like the capital intensity of the industry. Inpex stands out as the cheapest of its peer group, particularly given the rising project costs in the massive Ichty’s offshore project in Australia. Based on the work we’ve done, we think Inpex shows great value at these levels and we’re excited about the long-term opportunity it offers.”
Hertzog says that another recent purchase is Spanish television network operator, Mediaset Espana. "Advertising spend in Spain has fallen to levels last seen in the late 1990s and RECM believes the market is rating Mediaset Espana as if advertising will stay at these depressed levels. It’s an excellent business and we would have liked to have bought more, but the great European rerating started closing the gap to intrinsic value and we couldn’t get as much as we would have liked.
"European stocks still feature strongly in the portfolio, with European steel manufacturer ArcelorMittal the largest current holding. With many of the major holdings having run so strongly in 2013, the cash holdings in the Fund have increased to over 20%.”
Despite the Fund’s strong performance, Hertzog urges investors to temper their return expectations. "It’s very rare that the intrinsic value of companies will increase at the rate that global share prices increased in 2013, so it shouldn’t be surprising that the Fund’s cash holding increased substantially. Long-term returns from these levels should be solid, but we’ll be surprised if they’re spectacular,” warns Hertzog.
