Man GLG Continental European Growth Fund update Q4 2016 Performance review
RICHARD PHILLIPS: Hello, good afternoon. My name is Richard Phillips and I’d like to welcome you to the Man GLG Continental European Growth Fund conference call with my colleague Rory Powe. Rory is going to speak for about 20 minutes covering last year Q4 performance, as well as his outlook for 2017. So without any further ado I shall hand straight over to Rory.
RORY POWE: Thank you Richard, and thank you everybody for making the time to listen to this. It’s going to be a quick update on the fund. And I’m going to start by just covering the team, because we’ve been a unit now for just one year. Virginia and Ivan joined me at the beginning of 2016. Just to remind you I took over the running of this fund on the 1st of October 2014, so we’ve been running the fund now for just over two-and-a-quarter years, but I had reinforcements early 2016.
Our objective is to deliver returns of at least 10% annually. That’s our target, that’s our objective. And in order to succeed with that we need to find names that will give us those returns, and so we spend most of our time researching companies, either existing positions in the portfolio or new names. Today, I’m going to talk about how we’ve made some changes to the portfolio in the last 12 months, but all I’ll say at this stage is we’re very happy with the way in which the team is working together after one year. And just to recap on the philosophy, this is of course a very bottom-up stock picking fund, where the sectors and countries and their weightings are very much determined by the stock selection.
We’re looking for Europe’s strongest companies, and we see no reason to compromise on our insistence upon investing in Europe’s strongest companies. I’ll talk later about the split between what we call established leaders and emerging winners. If we’re successful in achieving returns of above 10% on an annualised basis, then we’re confident that we can beat the index, and that’s the way round we think about performance. We don’t set out to beat the index; we set out to deliver good returns. And as a by-product of that we hope to beat the index. Again, I’ll take any questions on that later.
Just to look at our performance so far, although we’re happy with the fact that since the 1st of October 2014 we’re comfortably ahead of our objectives that I just quantified, as far as 2016 is concerned it was a mixed year. And I’ll go into more detail on this in a moment, but it’s fair to say that we had a poor fourth quarter of 2016: we lagged the index quite significantly. And that meant that for the full year we were also behind the index. For the first nine months we were ahead of the index. We unfortunately lost that advantage in the fourth quarter, in particular in December, and I’d also make the point before anybody else does that all of, pretty well all of 2016’s absolute return came from the weakness of the pound, or rather the strength of Europe’s currencies versus the pound. So we can’t take any credit from a stock picking point of view for the very good absolute return achieved in 2016. Although thankfully since the 1st of October 2014 the majority, comfortably more than majority has come from stock selection.
So looking at Q4 in more detail, it was quite a challenging quarter for us, not least because the market was strong. The index in local currency was up by at least 6%. And as you’ve probably learned now with our fund, when the market is very strong we can be left behind. When the mega caps and the high beta names are performing well, it can be more challenging for us. In particular in December and the fourth quarter the banks were very strong indeed. Financials as a whole rose by above 20% in the fourth quarter, compared to an approximate 6% increase in the local index, and we have barely any exposure to banks. Energy was also a very strong sector, and that left us behind as well.
From a stock selection point of view, we had some winners in the form of Ryanair, Pandora, Actelion that was bid for by Johnson & Johnson, Autoliv, Moncler, but Novo Nordisk hurt us in the fourth quarter, even though we had halved weighting in it. Of course we should have cut the position outright in August. We’ve sort of learned that lesson. But belatedly Essilor struggled in the fourth quarter because its organic growth was slightly disappointing at the nine month stage. Glanbia’s finding itself in quite a promotional market at the moment, given that whey prices have been low now for some time; albeit beginning to recover and their competitors are being quite promotional. XXL which is a sporting goods retailer in the Nordic markets just had the wrong sort of weather. Not a good ski season up in Norway, Sweden and Finland in the fourth quarter of last year. But of those poor performers the only one that we would describe as sinister, and where we clearly got it wrong was Novo Nordisk, and we have cut that position outright now from the portfolio.
And then for the year as a whole, well as I said earlier we were ahead of the benchmark at the end of September, but we finished the year behind because of the shortfall suffered in the fourth quarter. It’s also fair to say that for the full year, 2016, some of our largest names, for example Christian Hansen, Ryanair and Essilor, experienced single digit percentage declines in their share prices in a year when if you strip out the currency effect the market was roughly flat. So anything that lost money in 2016 from a share price point of view contributed to our negative performance. But I would make the point that with those particular examples, Christian Hansen, Ryanair and Essilor, we’ve used their underperformance in 2016 to increase our weightings in them.
Thankfully a number of holdings that we would describe as tier two positions, names that have weightings of approximately 3% - a large position would be probably more than 5% of the fund – really kicked in and performed and helped offset the weakness in some of our biggest names. I’ve already mentioned Actelion. ASM Lithography (ASML) had an excellent year in terms of sales and profitability. Montcler is clearly on track to achieve revenues in 2016 of close to one billion euros, a very creditable year for them. And VAT, which is a position we added in March for the first time in 2016, its share price pretty well doubled between then and the end of the year.
They are the world leader in vacuum valves. I’ve probably talked to you about this before. We’re very happy with their progress. Not least the fact that in 2016 they’ve just recently reported their revenues grew more like 24% instead of the most recent upgraded guidance of 18%. So they’ve really exceeded expectations quite significantly thanks to the strength of their underlying market. A market that ASM Lithography (ASML) is benefiting from well, but also the shift to OLED screens versus LCD, and they’re very much in the vanguard of that.
But we can’t get away from the fact that in 2016 Novo Nordisk and Yoox Net-a-Porter were costly positions for us, both big positions. Novo Nordisk has been cut. Again I can answer questions on that later, but essentially the pricing environment for them in the US insulin market was more hostile than we envisaged. In the case of Yoox Net-a-Porter nothing terrible has happened; it’s just fair to say that their growth over the course of 2016 decelerated slightly. And we’ve got to remember that their share price was particularly strong in 2015 and contributed to outperformance in 2015 on the back of the merger between Yoox and Net-a-Porter.
So to summarise 2016 it was really a year of snakes and ladders. And you can see that in terms of the winners on the one hand and the losers on the other hand. But also if you look at the performance over the course of 2016 we had two good months, two poor months, two good months, two bad months. We finished on the wrong note in December. I’m pleased to say that we had a strong January, so this rotation if you like from month to month seems to continue. And I’ll talk about what we can expect later on, and if there are any questions on that. But it was a frustrating year I would say, it was a testing year, but it was also a year in which we were able to take advantage of share price weakness in a number of our highest conviction names. And so even though there was volatility in 2016 we chose to on many occasions embrace it, and take advantage of, in June for example over the Brexit vote, that was a very good opportunity to add to our positions in Ryanair, Kingspan, share prices were down by over 20% in that month. That was a good opportunity to do that.
And so when I come on to political risk in 2017 I look at it as a source of opportunity as well as a threat, and I don’t sort of begrudge the fact that there are quite a few risks in Europe at the moment. If there weren’t then Europe would be too fashionable, too crowded, and it would be more difficult for us to find value. We sold eight positions in 2016, and we added 10. We took the number of holdings up to 35. I would say our portfolio turnover of 72% was higher than normal, higher than what you would expect from this fund. Not significantly so. There was a bit of a subtle shift in favour of more European centric names versus global, but not material. And we’ve increased, we’ve continued to increase the exposure to emerging winners, and they now represent 23% of the portfolio. To remind you we have a cap of 33% exposure to those positions. And of course to repeat we reinforced our weightings in quite a few stocks. I’ve already mentioned Ryanair but we added to Pandora, Montcler, Christian Hansen, ASM Lithography (ASML), Eurofins, Geberit, Loomis, Autoliv, just to mention a few.
As a result this is how the portfolio looked at the end of 2016. It hasn’t changed significantly since. Again to remind you we will never have more than 40 stocks in the portfolio. We’re bang in the middle of our range of the 30 to 40. We’re pleased that we’ve slightly increased the exposure in emerging winners, and I think we’ll continue to do that. We need to future proof the portfolio. There’s so many changes going on in the world today, and we need to reflect that in the portfolio. And never be complacent about the incumbents, the companies which dominate, the established leaders, always be aware of any potential threat to their hegemony. The local weighting I’ve already explained. The market cap profile is as you can see. Versus the index we’re significantly underweight mega caps, because we will always view this fund as being an all cap fund, as a fund that includes big, small, medium sized companies, and hopefully a good balance between. You can see the top 10 positions.
And finally before we open up for any questions I think it’s fair to say that the European economy is proving to be resilient. You will have seen the numbers yesterday, preliminary numbers for the eurozone showed that it grew by 1.8%, which is not far off what the UK achieved in 2016, and at first glance superior to what the US achieved in 2016. So we’ve been arguing for some time that we shouldn’t underestimate the resilience of the European economy and its preparedness to recover; albeit in a hesitant way. And that continues. The inflation number for the eurozone of 1.8% yesterday, this is the early numbers for January, is significantly higher than where it was in December, which was higher than where it was in the previous months: December it was 1.1%. Underlying inflation for the eurozone is running at 0.9% at the moment.
So we don’t expect the ECB to change its policy in terms of keeping its interest rates where they are, and continuing to pursue its quantitative easing at least to the end of December at a rate of €60bn per month. And I think it’s welcome the fact that deflation has been kept at bay and that there is some inflation now in Europe and that will give pricing power to more companies. But we still think that pricing power will remain scarce, because even if wage costs are creeping up and input costs are rising, we think a lot of companies will struggle to pass those input costs on to their end consumers when demand in Europe remains pretty fragile. And so even though bond yields are rising in Europe, they still remain low by historical standards. And even if they go higher, which they may well do, we think they will remain low by historical standards. There’s a significant overcapacity in the European economy still today and demand is still relatively fragile.
On political risk, this is not really the occasion to talk at length about the French presidential elections. I think it’s fair to say we mustn’t underestimate these risks, particularly the French presidential elections – the second round in May – but equally I don’t think we should overestimate them either, and I think people are being premature in questioning the integrity of the eurozone. And I think we mustn’t underestimate the sustainability of that project, despite comments from President Trump, which if anything may well make Europe just be more shoulder to shoulder than ever before, and consolidate more.
We try not to be too distracted. We will take the risk seriously. When they’re exaggerated we’ll take advantage of the opportunities they present, as we did for example, we were able to add to our Montcler position ahead of the Italian referendum, because we just felt that the market was exaggerating its significance. And equally we don’t want to get too hung up about the argument in favour of value versus growth, or growth versus value. If bond yields rise, and if inflation continues to creep up, it’s going to be more challenging for us. But, we believe it’s far from inevitable that we will underperform in an environment of rising bond yields, not least because we don’t expect them to rise significantly. But also I hope our portfolio is not guilty of being full of what I would call bond proxies.
Interestingly if you look at the sector profile of the portfolio, we are underweight consumer staples. We’re underweight telecoms, we’re underweight utilities. We’re underweight those defensive quarters that often get described as being bond proxy. Whether we perform well or not instead really should rely upon our stock selection. If we get our stocks right I think we’ll be rewarded. If we get them wrong, as we did on too many occasions in 2016, we will be punished. The market will remain as Darwinian as ever, and that’s the market we like. That’s the market we want.
So we think this is an environment in which we can continue to deliver on our return objectives with mind to 2020, Ivan, Virginia and I when we’re looking at our stocks we’re thinking about where are these companies going to be in five years’ time? That’s right now, 2020 because 2016 is still year one until they’re out and reported and audited, and where do we think the share prices and the valuations of those stocks will trade in relation to those forecasts of ours – that’s what we’re thinking about. And we’re very happy with the portfolio today. And even though 2016 was a challenging year, most of the time the news flow from our companies reinforced our conviction in them. Thank you.
RICHARD PHILLIPS: Thank you very much Rory. Given Donald Trump’s comments about Germany do you have any particular view on euro/dollar or euro in the next 12 months?
RORY POWE: I think that the strength of the dollar that we’ve seen versus the euro might run out of steam, Because I think the European economy is performing better than expected at the moment. And I think markets will also maybe question the optimism relating to Trump’s fiscal plans, his infrastructure plans, his plans for less regulation, and there may also be a bit of a backlash in his direction. And it’s also fair to say that I think people are probably exaggerating the political risk in Europe. Investors, we all tend to fight yesterday’s war, and because we all were probably surprised by Brexit and Trump we’re now overcompensating by expecting the worst with the elections in Europe. And I don’t, we shouldn’t underestimate Europe’s desire for stability, and I think that could be reflected probably in a relatively stable currency versus the dollar. I’m not a currency expert but in terms of our stock selection we’re not relying upon any major moves in currencies either way.
RICHARD PHILLIPS: The next question I have is on the number of names in the portfolio. You currently have 35, how many do you have on your watch list?
RORY POWE: Yes, thank you. We’ve got approximately 300 names that we describe as companies that already loosely meet our criteria. And we’re able to say that because we’ve met them before, we’ve done the research on them before, we’ve held them before, and so that’s what we rather pompously describe as our hinterland. But in reality is it a pipeline of new ideas. It’s less than the number of names in the portfolio, and actually having added eight names in 2016 we’re now of the mind that we’ve refreshed the portfolio. Hopefully, we’ve reinvigorated it with names like Ienna and Delata and now it’s about optimising our positioning in the right stocks. And I think we’re all guilty as portfolio managers of not spending enough time thinking about sizing. And often the best idea is in your portfolio, why is it only 3% of the fund, why is it not 6% of the fund? So I don’t expect us to add many new names, but if we do it’s probably going to be in the emerging winner category.
RICHARD PHILLIPS: Thank you Rory. Well that looks like that’s the questions for today. So thank you all very much everyone for dialling in, but for now thank you very much.
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