Andrew Paisley, the Citywire A-rated manager of Standard Life European Smaller Companies fund, is seeking shelter in founder-run businesses on the Continent amid signs the UK consumer is coming under pressure.
The British Chambers of Commerce economic survey for the second quarter points to a significant decline in cash flow and investment intentions in consumer-facing service industries, such as hospitality and retail, owing to subdued consumer spending.
Paisley has recently bought France’s Interparfums (IPAR.PA), which designs, makes and markets branded fragrances, after visiting the company in Paris last summer. Chief executive Philippe Benacin co-founded the company in 1985 and retains a significant shareholding. ‘He’s got skin in the game,’ said Paisley.
The company has developed fragrances for brands including Montblac, Coach and Lanvin. Paisley expects a wealth of investment in scents for new brands is expected to bear fruit in 2019 and 2020. ‘It has fantastic growth potential,’ he added. ‘What we’re looking to do is buy tomorrow’s bigger companies today.’
He also likes Germany’s ‘Mittelstand’ – an engine room of mid-sized growing companies – and has holdings in a number of firms whose founders are significant shareholders.
These include Nemetschek Group (NEKG.DE), a vendor of software for architects, engineers and the construction industry that was founded by Professor Georg Nemetschek in 1963 and has successfully expanded into the US in recent years, and Grenke (GLJn.DE), an equipment-leasing firm for small businesses that was founded by Wolfgang Grenke in 1978 and has expanded throughout western Europe. Grenke retired earlier this year, but remains its biggest shareholder.
One half of the fund’s €753.6 million (£667 million) of assets is in the UK and Germany. It has almost 29% in companies listed on the UK stock market and 20% in those listed on the German stock market – a 3% underweight and 10% overweight respectively versus the FTSE Developed Europe Small Cap index.
Paisley has recently changed the underlying composition of his UK holdings on the back of trends identified from the output of the fund manager’s proprietary stock ranking tool, known as ‘the matrix’, which is updated weekly.
‘Matrix scores for a number of the domestically-focused names turned negative in the months following the Brexit vote,’ he said. ‘Conversely, the scores for more internationally-focused names improved significantly.’
Over the first half of last year he sold out of bakery chain Greggs (GRG), soft furnishings retailers Dunelm (DNLM) and kitchen manufacturer Howden Joinery (HWDN), and bought specialist asset manager Intermediate Capital (ICP), engineering company Fenner (FENR) and industrial valve maker Rotork (ROR). Fenner has been a particularly good addition: French tyre maker Michelin agreed a deal in March to buy it at a 30% premium to its share price.
‘It wasn’t a knee-jerk reaction: the matrix scores don’t tend to jump about so it took a while for the changes to the outlook to be reflected in the numbers, and some time again for us to make the changes,’ he added.
Developed by Standard Life Investments in the mid-90s, the matrix measures value, growth, quality and most importantly momentum based on 13 factors that the quantitative team believes are particularly predictive of share price performance.
‘We look for [share] price momentum, but moreover earnings momentum and we see this continuing to deteriorate for UK domestic earners; there is evidence that the UK consumer is coming under pressure,’ said Paisley.
The screening process takes the European smaller companies universe of 1,000 stocks down to a shortlist around 200. From these, he builds a portfolio of 40 to 50 stocks (46 at present), which he typically holds for three to five years.
‘As long as we feel the market is under-appreciating the growth potential of a business we will continue to own it,’ he said, pointing to a turnover rate of just 17% during 2017.
Despite his current caution on UK domestic names, London-listed holdings have done well for the fund. His three top performers last year were all British businesses – premium drinks mixer manufacturer Fever-Tree (FEVR), construction company Morgan Sindall (MGNS) and Intermediate Capital. Their shares rose around 95%, 90% and 65% respectively during 2017.
‘There’s a high degree of persistency with smaller companies – if a company has got something special about it, it’s not going to be competed away easily,’ he said.
‘There are still fantastic stock ideas in the UK despite everything going on with Brexit; it’s a stock-pickers' market, but you’ve got to be selective.’
Paisley is not keen on financials and is around 10% 'underweight' the sector compared to his stock market index benchmark: ‘Many of these companies, particularly in the banking segment, are not particularly transparent and fail to meet our quality criteria,’ said the manager.
He also avoids speculative and loss-making companies, such as early-stage technology companies or oil and gas stocks with no turnover or profits.
‘A return to more volatile market conditions makes our focus on high quality companies with good growth prospects and momentum the best place to be,’ added Paisley.