Q&A: Marlborough European Multi-Cap investment update

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Marlborough European Multi-Cap Fund Manager David Walton explains why he is upbeat about the outlook for European equities and why he believes lockdown winners can continue to grow as we emerge from the crisis.

How would you describe the investment outlook for Europe?
“While clearly there are risks as the world navigates a way out of the pandemic, we’re pretty positive about the investment outlook for Europe.

“There’s substantial pent-up demand, because lockdowns and other restrictions have meant households haven’t been able to spend money. People haven’t been commuting, going on holiday, spending in non-essential shops or socialising to the same degree in bars and restaurants.

“That means as restrictions are lifted people will have more money in their pockets and they’re likely to spend it in Europe, since travel further afield is likely to be limited for some time. We have a preference for smaller companies, which tend to be more domestically focused, so they’re well positioned to reap the benefits of this release of pent-up demand.

“Companies have been restricted too in terms of their teams travelling and meeting with contacts, so that’s acted as a brake on M&A activity. While the travel and leisure sectors have had a tough time, many other companies have been busy building up their balance sheets and now have more money for acquisitions.

“That expected increase in M&A activity, with smaller companies bought at attractive premiums, is likely to be another positive for the fund. We’ve already seen Norway’s biggest bank, DNB, make a bid for a smaller online-only bank we hold called Sbanken.

“On the less positive side, vaccination programmes in Europe are lagging behind where we are in the UK, but governments are working hard to catch up and certainly we’d expect a gradual lifting of restrictions and for business activity to be much closer to normal levels by the end of the year.

“Inflation does pose a risk. Prices of raw materials and energy have increased, as suppliers struggle to keep pace with resurgent demand, but we’d expect that to be a short-term issue. Companies may experience some margin pressure, but we’d expect them to successfully pass on higher costs to their customers.

“If European policy-makers were forced to raise interest rates to head off a sustained rise in inflation that would be a negative for equity markets generally. However, governments are heavily indebted and are likely to use all levers available to keep borrowing costs low.

“Governments will also be well aware of the risks to economic growth if they move too hastily to withdraw support measures introduced to help businesses and individuals during the crisis. As a consequence, political leaders have made it clear this process will be managed very carefully.

“So, while macroeconomic risks cannot be ignored, we’d expect our companies to continue to grow successfully, supported by positive tailwinds for smaller businesses in particular.”

What’s the trading environment like for individual companies?
“The signals are definitely positive. We’re seeing a lot of European companies upgrade their earnings forecasts for the first quarter of 2021, which suggests we’re going to see a pretty strong bounce back.

“What’s interesting is that sectors that were winners during lockdown – such as ecommerce, home renovation and consumer electronics – remain strong this year. Perhaps that isn’t too surprising because many European countries are still locked down to a greater extent than we are in the UK. At the same time though, we’re seeing some of the harder-hit sectors starting to bounce back too. So, for example, car retailers are seeing business pick up and they’re upgrading their earnings forecasts.

“We’re also seeing upgrades from process industries like steel makers and chemical producers. That’s another positive indicator, because increasing demand for these products is a sign of a broader recovery in industrial activity. In addition, we’re seeing higher prices for wood pulp, which is used in everything from printer paper to cardboard packaging, and that’s another signal of increasing industrial activity.

“We won’t though be making any significant changes to the portfolio in anticipation of the bounce back. So, we won’t, for example, be switching into more cyclical sectors. Companies we hold that have been lockdown winners were originally selected for the portfolio because they have strong multi-year growth drivers. Those factors will remain in play when restrictions are lifted, and these companies will continue to have strong growth prospects.

“Finnish sauna maker Harvia is one example. The company has done well during the crisis, as people in lockdown have spent money improving their homes. As we look ahead to a post-crisis world, Harvia is still well-positioned for expansion in what is a large and undeveloped market for saunas in the US, which should present growth opportunities for years to come.

“Another example is Sesa, an Italian wholesaler of IT hardware and software. Like many technology companies, Sesa has been a lockdown winner, but there’s a longer-term growth driver, which is Italy spending to catch up after what have been many years of under-investment in IT systems.”

Where have you been identifying new opportunities for the fund?
“After last year’s volatility, European equities are now pretty buoyant, which is clearly positive for the fund. Higher valuations do though mean we’re being pretty selective about adding new companies.

“We’re seeing quite a lot of IPOs by relatively unproven companies that are often not yet in profit. That’s not the type of business we’re looking for, so we’re steering clear. Our approach is all about identifying companies that have a proven track record but are cheaply valued compared to their growth prospects. Europe’s home to a vast range of companies and even when valuations are higher there will always be opportunities, because of the under-researched nature of the market.

“We’ve taken a position in a Swiss company called u-blox, which makes modules used for machine-to-machine communication in industrial plants and other sites. Lockdowns have slowed down the rollout of these systems, but longer term we think there’s a strong growth story here. We’d expect that after the COVID crisis companies will be keener than ever for their machines to be interconnected and able to function effectively with lower levels of human involvement.

“We’ve also made a new investment in a Swedish company called Hexatronic, which supplies fibre-optic cabling to improve performance across telecom networks. The company’s benefiting as fibre-optic replaces copper cable for the final ‘last mile’ telecom connections to individual homes, particularly in the US and Europe. We think Hexatronic has a strong position in a growing market.

“While we generally favour smaller companies like u-blox and Hexatronic, we’re a multi-cap fund and, at the other end of the market cap spectrum, we’ve invested in multinational German business software group SAP. The company disappointed the market last year with the speed at which it’s rolling out its cloud-based software. We think though that after management changes and with an improved strategy it’s moving back on track.

“These are three very different companies, but what unites them is that, in our view, the market hasn’t yet priced in their strong potential for growth. We believe that presents a clear opportunity.”

What role do ESG considerations play in your investment process?
“While we don’t have a specific ESG mandate, these considerations are definitely an integral part of our investment process. Our approach is to invest in well-managed companies and we take a clear view that this includes taking ESG responsibilities seriously and acting on them.

“We have a preference for smaller companies, which because of their size tend not to be covered by the ESG data suppliers. So, we collect our own data relating to a range of ESG considerations, ranging from female representation among the management team and directors through to the independence of the chair of the board. We’ll also look at what disclosures the company makes on issues such as climate change.

“Ultimately, because of our commitment to investing in well managed companies, we wouldn’t consider investing in a company with a poor ESG profile, even in the expectation that it’s going to significantly improve. What we’re about is investing in companies that are already well managed and ESG is an important part of that.”

David Walton 28/04/21

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