Fund in Focus: European Special Situations

He discusses two companies with what he believes are strong growth prospects and that, in his view, look undervalued at current share prices.

He also explains why hasn’t been tempted to change his investment strategy despite a challenging economic environment and shares his insights about the market outlook.

‍

Fund in Focus: European Special Situations October 2023

Transcript:

[00:00:00] Nick Peters: Hi, this is Nick Peters, Investment Advisor for Marlborough and welcome to this week's podcast.

[00:00:07] I'm very happy to introduce David Walton, the manager of the Marlborough European Special Situations Fund.

[00:00:13] David, welcome.

[00:00:15] David Walton: Thank you Nick. Nice to be here.

[00:00:17] Nick Peters: So usually we start off with a gentle opener. So please give us an overview of the fund, what it's striving to achieve and how?

[00:00:25] David Walton: The funds objective is to achieve the highest possible long-term total returns for unit holders and it does that by investing in European companies, mostly smaller companies, which we think have an above average growth potential, an excellent management team and where the shares are cheaply valued compared to their prospects.

[00:00:49] Nick Peters: Can you perhaps give us an example of a stock that's currently held in the portfolio?

[00:00:54] David Walton: Sure, so we hold the French company Delta Plus, which sells personal protective equipment, so a safety hat, safety gloves, safety shoes, anything you have to wear if you're working in construction or any sort of industrial process.

[00:01:10] And this company is a good illustration of our process because probably you've not heard of it, people listening to the podcast haven't heard of it either.

[00:01:20] This company is about 1/20th the size of the well known company Bunzl, which is a FTSE 100 company in the UK, which is doing the same thing. So our approach is to look for companies under the radar screen of most investors which are executing a good growth strategy, they're simply not that well known, and therefore often their shares are cheaply valued compared to peers.

[00:01:46] So Delta Plus's shares are valued at a discount of 1/3 compared to Bunzl and yet it has grown somewhat faster than Bunzl over the last 10 years and a s I said to you market cap today is 1/20th that of Bunzl but the company is doing a fantastic job making small acquisitions to increase its market share both in Europe and North and South America.

[00:02:10] Nick Peters: Thank you. The long term performance of the strategy is excellent, but there have been some bumps in the road more recently. Perhaps you can elaborate on that?

[00:02:21] David Walton: Yes, the funds have certainly done well over the longer term with the unit price almost trebling since Cannacord was the advisor to the funds from October 2013.

[00:02:30] In more recent time, last 18 months, performance has been less good, so year to date the fund is down 2%, and last calendar year, 2022, it was down 16%.

[00:02:43] The reason for that really is quite simple, mostly, it's because the fund invests mainly in small companies. They have underperformed compared to large companies in Europe because they are more sensitive to European economic growth.

[00:02:58] That has been downgraded due to the well known economic slowdown. Small companies are also more sensitive to interest rates and inflation.

[00:03:07] So they are having to pay more for their loans because of increased interest rates. Equally, due to cost inflation, they are facing a cost squeeze for the time being, so that really explains the fund's more recent performance.

[00:03:22] Also, in terms of our strategy, we are buying growth companies at cheap valuations, and that drives us to own somewhat more cyclical companies compared with the average in the market.

[00:03:33] So, our biggest weighting is the industrial sector at 30%. We have seen a number of downgrades there over the last year and a half.

[00:03:43] That, of course, is going forward the opportunity because we're investing in a company which can grow over a business cycle, so it may not grow every year, and during a recession or a slowdown, profits may well fall.

[00:03:56] But as long as the company can carry on investing in this business, then when we emerge from this slowdown into more healthier times, the company will have a bigger footprint and can then resume its profit growth with a larger sales base.

[00:04:09] Nick Peters: There are some commentators who feel interest rates could go higher in Europe and ultimately push the economy into recession. You've sort of touched on what impact that could have on smaller companies.

[00:04:21] Could you give us a bit more colour on that?

[00:04:23] David Walton: Yes, I suppose I would say that firstly, we are stock pickers. We are not ourselves making an economic forecast. So we are simply taking what we hear from economic forecasters and using that for our stock selection decisions.

[00:04:38] It's worth saying that a recession in Europe has been widely 2022. Hasn't actually happened yet.

[00:04:47] It might happen next year, but a recession was predicted for this year And now that isn't going to happen. A clear slowdown, yes, but not a recession this year.

[00:04:58] Next year the European Central Bank is forecasting growth of 1% in the eurozone after 0.7%this year.

[00:05:07] So that's the scenario that we're working with is a clear slowdown but not necessarily a recession. In terms of whether interest rates and inflation have peaked, that is obviously a very difficult call to make.

[00:05:21] I think what we're hearing from companies really is that at the moment they are seeing, for example, still relatively high increases in salaries and also energy costs are going up due to the expiration of fixed price contracts for energy.

[00:05:36] So there still is inflation coming through, but at the same time, we're also hearing that for the salary agreements in a year's time management teams expect a much lower increase.

[00:05:47] So we are beginning to see a lessening of the inflation pressure on companies, albeit it's quite a gradual lessening at this point.

[00:05:58] Nick Peters: You mentioned earlier that you're primarily bottom up stock pickers. What attractive opportunities are you seeing in Europe at the moment?

[00:06:06] David Walton: Well, we cast on that quite widely, both across different sectors. We look at also some mid and large caps, as well as small companies. So within the mid and large cap sector, typically in the healthcare sector, we quite like the Danish pharma company Lundbeck, which is, let's say, a much less well known little brother to the giant NovoNordisk, which we also hold.

[00:06:30] But looking at Lundbeck, which is a much smaller company, although still a mid cap in Europe, this is a company which is focused on neurology, which has been a difficult to treat disease area for pharma companies.

[00:06:43] And we think that Lundbeck has an advantage here by focusing entirely on neurology. And it succeeded to bring to the market a drug now for Alzheimer's agitation, which currently has no recognized pharmaceutical, approved by the FDA.

[00:06:59] So in care homes, doctors are having to use anti psychotic drugs off-label to treat patients. So this is a clear improvement in that situation.

[00:07:09] And that company is on a relatively low PE of 12 times as well, so not particularly expensive and we're seeing really an improvement there in Lundbeck with a new management team having had a previous team which did not do particularly well pushing through pipeline drugs, which explains why the share price has come down before we bought it.

[00:07:30] Nick Peters: Some listeners might be thinking that if it's a challenging year for the fund, why not change your approach or perhaps change the strategy to something that does work? Would you be tempted to do that?

[00:07:42] David Walton: Not particularly, I think we've been appointed advisor for now for 10 years now, and the average fund turnover over that time has been roughly 15-20% so we're holding shares for five, six, seven years sometimes.

[00:07:55] Our approach is a patient approach to buy and hold and to hold a company as it grows through a business cycle, whether it's going well or badly. Cycles are cycles and no particular condition always lasts forever during a cycle, so currently we're in a slowdown with rising inflation and rising interest rates.

[00:08:14] That cannot go on forever, so, the main thing really is, is to invest in well managed companies with good balance sheets that can ride out more difficult times and then be ready to capitalize on renewed growth in the economy when it comes through. That's really what we're waiting for.

[00:08:31] So I think it probably would be a mistake to, let's say, sell down companies now which are more cyclical, in the industrial sector for example, to buy utilities or food retailers which are certainly defensive, but then would not have any benefit from any improvement in economic growth in Europe.

[00:08:50] Nick Peters: And how would you categorise the investment outlook from here?

[00:08:54] David Walton: I'd say it's cloudy, so the sky is definitely cloudy.

[00:08:57] So, we've discussed these headwinds already, interest rates, inflation also, the war in Ukraine is a clear headwind in Europe, so it affects consumer confidence as well.

[00:09:09] So, the sky is cloudy, but the point here is that, I think, if there are no new headwinds next year in Europe, then that in itself would be an improvement compared to this year and last year.

[00:09:23] So, last year we had, firstly, the war, then we had rapid inflation, then we have the interest rates beginning to tighten. This year we've had more interest rate tightening and inflation being quite hard to control.

[00:09:37] So, I think you've had a series of headwinds emerging over the last two years, so, looking forward, just the absence of new headwinds in itself would be a positive.

[00:09:47] And then, if any of these known headwinds begin to ease, that would be a further positive.

[00:09:54] Nick Peters: Thanks very much for your time, David.

[00:09:56] David Walton: Thank you, Nick.

[00:09:57] Nick Peters: If you'd like to find out more about the European Special Situations Fund, please visit the Marlborough website. Thank you.

‍

These are the investment manager’s views at the time of recording and should not be construed as investment advice. The opinions expressed are correct at time of recording and may be subject to change.

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed.

An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.

Marlborough Investment Management Limited. is registered in England and Wales at Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP with company no. 10947598.  

Marlborough Investment Management Limited. is regulated by the Financial Conduct Authority with FCA Reference no. 115231.

Marlborough is the trading name of Marlborough Investment Management Limited.