A flaw in the human psyche is the only possible explanation for why people don’t buy regions when they are out of favour, according to Waverton Investment Management’s Charles Glasse, who says waiting for sentiment to turn and valuations to bounce back makes no sense from an investment point of view.
Glasse, who runs the offshore, five FE Crown-rated Waverton European Dividend Growth fund, said the reason Europe is out of favour among international investors at the moment is due to political unrest and sluggish economic growth within individual countries.
Data from FE Analytics shows the MSCI Europe index has made less than half the gains of the MSCI World over the past five years.
Performance of indices over 5yrs
Source: FE Analytics
“A lot of the swing investors in Europe have sold a lot of shares in European companies over the past nine months,” said Glasse.
“And the swing investors tend to be Americans, usually because of a rising dollar. In their eyes, the value of earnings coming from outside the US is falling so they tend to dump them because they will underperform their global portfolio.
“But when the dollar sort of levels out, then they tend to look around and say ‘actually these European companies’ earnings are rising faster in dollar terms’ and they pile in.”
As a result, Glasse said the best time to buy the European market is when it is most out of favour.
To illustrate his point, he highlighted a chart of relative asset flows showing that the five previous occasions over the past decade when sentiment towards Europe was at its weakest correlated closely with the highest subsequent six-month returns.
Source: Exane
“I say that to investors all the time: ‘Buy Europe when everybody hates it’,” he continued.
“Do they do it? No. I’ve never quite understood it really. Some things are not that difficult. But you know when sentiment is bad, it is very difficult to do the opposite
.
“There is something in the human psyche that stops people from buying low and selling high. And it is this thing about doing something different. But that is what we like to do.”
Of course, the counterargument to this point, as anyone who has ever tried to call the bottom of the market is likely to attest, is that you never know how much further a stock, sector or region is likely to fall.
However, the manager pointed out that international investors will regularly sell out of Europe on fears of what is happening within the region, when in reality the average company makes half its sales outside the continent, a figure that rises for sectors such as oil & gas, energy and materials.
As a result, he said buying European-listed global companies at this point represents “the great opportunity for making money in Europe in the long term”.
Many European-listed global companies have historically traded at discounts to their US-based peers, even if the gap has not been as wide as its current level. Glasse (pictured) said this is due to the difference in return on capital employed (ROCE), with this figure typically much higher in the US where there is more of a focus on efficiency and optimising returns as “it is just part of what is taught in business school”.
“What happens is that over long periods of time, essentially two businesses, something like an industrial gases company in the US and an industrial gases company in Europe, the profitability of the US company will be much, much higher than that of the European company,” he explained.
“And it is not because they are in a different business, it’s simply because the guys in Europe haven’t used their pricing power whereas the guys in the US have.
“There are all sorts of reasons why they’ve not used their pricing power in Europe. Linde, which was a big German industrial gases company, had unions on its board, so there was no real sort of push.”
However, a focus on ROCE plays a major part of Glasse’s investment process and he believes the gap between the US and Europe is beginning to close, with many countries becoming more shareholder-focused.
For example, the manager described Scandinavia in particular as “full of companies that are doing all the right things”, which he attributed to a smaller state that refuses to bail out failing industries.
“Whereas in France and arguably bits of Germany, France simply hasn’t the management, it has simply not understood how companies should be run to be most efficient and most competitive,” he added.
“Of course, the people who are running French companies now were at business school 30 years ago, when they were teaching all sorts of… I don’t know what they were teaching at French business school 30 years ago, but it was obviously something very different to what they were teaching in business schools in Norway, Sweden and Denmark.
“But that will change,” he continued. “And I wouldn’t be surprised if it already has changed. The next generation of people coming through the companies will be different.
“In fact, I have just bought shares in a French company that has got a big Belgian contrarian shareholder and it has just appointed a new chief executive who is a Dutchman. He’s got a good track record. He’s in the industry and I think probably it’s the first time he has been given a free reign to change the way this company is being run.”
Data from FE Analytics shows Waverton European Dividend Growth has made 173.76 per cent since launch in late 2005 compared with 174.29 per cent from the MSCI Europe ex UK index and 130.34 per cent from the FO Equity Europe inc UK benchmark.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £47.4m fund has ongoing charges of 1.3 per cent and is yielding 4.2 per cent.