Funds to watch: European Special Situations

Why do you and the team favour small caps?

While we have the freedom to invest in companies of all sizes across Europe, we have a strong bias to small caps.

The reason we favour companies at the lower end of the market-cap spectrum is we believe European small caps with strong growth prospects are often overlooked by the vast majority of investors, simply because of their size.

Far fewer analysts and fund managers are looking at these stocks and this creates an opportunity to invest in quality companies with highly capable management and robust growth potential while valuations are still relatively low.

Now, with quality smaller companies in unloved sectors on significantly reduced valuations, we are seeing what we believe is highly attractive value in the companies in our portfolio.

Look past the near-term headwinds and we believe current share prices do not reflect the strong long-term growth potential of these companies.

Can you give a brief overview of your strategy in terms of what you are trying to achieve for investors, your investment process and the make-up of the investment team?

We seek to achieve strong capital growth by investing in European companies we believe have excellent long-term prospects.

Small caps are our primary focus, and we look for companies with high-calibre management, a proven business model, relatively low debt and above-average growth potential. Most importantly, we look for businesses on valuations that look cheap relative to their growth prospects.

We have an investable universe of approximately 4,000 stocks, which we narrow down to a focus list of 200-250 companies, from which we select our portfolio of between 70-90 stocks. We aim to meet each company on the focus list once every 18 months and the management teams of our portfolio companies on an annual basis. We place a high importance on quality management and engagement with companies is an important element in our investment process.

I am the fund manager and I have more than 30 years’ investment experience. I have been managing Marlborough European Special Situations for more than a decade and prior that I ran European equity funds focusing on smaller companies for Baillie Gifford and M&G.

I work with two highly experienced analysts, Tom Livesey and Steve Robertson, who between them have well over 30 years’ investment experience.

What is your outlook for the fund and how are you positioning your portfolio as we move into 2024?

Slowing economic growth, rising interest rates and stubbornly high inflation are presenting clear headwinds for European companies in the near term, and inevitably we have seen share prices decline as a result.

However, for selective investors taking a long-term view, we believe this share price weakness represents an attractive opportunity to invest in high-quality businesses with outstanding growth prospects at significantly lower valuations.

Well-managed small caps in unloved business areas such as industrials and consumer-facing sectors are now looking particularly attractive.

The opportunity is more pronounced because there is less research focused on stocks at the lower end of the market-cap spectrum. There are an average of 26 sell-side analysts looking at every European mega-cap company, according to Canaccord. But there are, on average, only four looking at each small-cap company and for micro-caps the average is just one.

For investors taking a selective approach we believe this is presenting interesting opportunities to invest in quality small-cap businesses in out-of-favour sectors at substantially reduced share prices.

We are not the only ones who believe the current valuations of some European smaller companies look appealing. We have seen a flurry of merger and acquisitions activity this year, with bids for four companies we hold in the fund.

The headwinds currently facing European companies will not last forever and past experience shows when concerns begin to ease, markets can rebound swiftly. Investors sitting on the sidelines could risk missing out on significant gains.

Can you identify an investment opportunity you are playing in the fund at the moment? This could be at a stock, sector or thematic level.

Economic uncertainty has undermined business and consumer confidence and led to a significant sell-off in industrials and several other sectors. This has left a number of quality small-cap companies trading on what we believe to be highly attractive valuations.  

A good example is French company Mersen, which makes sophisticated components for electric vehicles and specialist equipment used in manufacturing semiconductors and solar panels.

The company is targeting an increase in annual sales of more than 50% over the next five years, from €1.1 billion in 2022 to €1.7 billion by 2027. Mersen is trading on a P/E multiple of 10x, at the time of writing. We believe this is highly attractive, given the company’s growth prospects.

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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.