Citywire AA-rated John Bennett outlined the battle he is facing in a ‘messy’ Europe beleaguered by deflation.
Henderson Global Investors’ director of European equities has a 27-year track record in the asset class and believes one of the big dangers for fund managers this year is that they take their eye off the ball amid the uncertainty.
‘2015 will be a year when it is really easy for fund managers to be deflected from what really matters,’ he said at a Henderson investment conference. ‘This will be a noisy year for macro, but I will continue to focus on what really matters, which is cash.’
On a valuation basis Bennett (pictured) views Europe as being cheaper than the US, but he said this does not automatically make his investment region a better option
‘The US is seen as a safe haven and the “Big Daddy” market is looking a bit expensive. While Europe looks cheaper, it would be disingenuous to say it needs to mean revert because of the US.
He added: ‘The European index has more troubled sectors than the US, even when financials are stripped out. We have more lumbering oil and utility firms, whereas in the US they have got more growth technology stocks.
‘Europe is at a discount because there is lot more rubbish and badly managed companies here. Yes, it is cheaper than the US but that’s really not a lot to write home about.’
However, he sees more potential in Europe than across the Atlantic right now, arguing margins on the Continent ‘have more chance of getting off the floor than US margins have of hitting the moon’.
One major force helping European firms is the decline in the euro.
Bennett considers it essential that the weakness in the single currency continues in order to prevent major turbulence. ‘The euro is finally giving some oxygen to companies and it needs to remain weak,’ he said.
‘The biggest macro trade out there is buy dollar and sell the euro and God help Europe if that reverses. [Also] oil sucks capital out of emerging economies and they could be forced to devalue their currencies, which could impact the euro.’
Dash for yield
Bennett’s major concern is deflation, which in turn is leading to a dash for yield, increasing valuation multiples on quality growth stocks as a consequence.
‘You have a grasp for yield going on and when you look back in history it always ends badly,’ he said.
‘I see a great fault line in emerging market bonds where the oil price fall could rupture certain emerging market economies. The entrance for money that has gone in searching for yield was wide but the exit is narrow. You have also got a situation where ETFs are trading against each other.’
With the European Central Bank poised to launch quantitative easing (QE) to combat deflation, Bennett is concerned about the effect this will have on his portfolio, which he tilted towards quality growth in the second half of 2014.
‘My biggest fear is for the nifty-fifty. In the last three months quality growth shot up and QE will favour bond-like equities, meaning investors will overpay for safe growth stocks.’
With valuations likely to escalate, Bennett is happy with the way his European Selected Opportunities fund is positioned, in anticipation of valuations getting ‘sillier’ before a correction.
The portfolio currently sits on an enterprise value (EV) of 13x and price to earnings (P/E) ratio of 17x.
‘I don’t go north of 20x earnings, it gives me a nosebleed. I shouldn’t be worried about a EV ratio of 13x but I’m worried it could go to 16x,’ Bennett said.
‘[However] my feeling is we’re going to get silly multiples in Europe. We tilted the portfolio back to quality growth on the basis that prices will be getting higher until the starvation for income ends, which won’t be soon because of deflation.’
He added: ‘Yes, quality growth is expensive, but I think it will get more expensive until this abnormal world dynamic changes and we get inflation. Until then, I’m happy not to change anything about the portfolio just yet. Deflation will turn at some point but only when fund managers’ portfolios are at 30-40x, then we will get that rout.’
In this complex investment environment he is backing the Benelux banks and is starting to turn positive on telecoms.
‘Something interesting is going on with telecoms, the regulators are more friendly now and this could be a game changer. During the last 10 years the telecoms sector was all about the consumer and the next 10 it could be all about capital return.’
Over the three years to the end of December, the Henderson European Selected Opportunities fund has returned 56.5% versus a peer group average of 49.8%.
Bennett also manages the Henderson European Focus fund, which has returned 62.1% over the last three years and is the tenth best performer in the peer group.