Investors need to stop looking at the top-down negatives in Europe and focus on the “excellent” companies within the market, according to Baillie Gifford’s Tom Walsh.
The manager of the five FE Crown-rated Baillie Gifford European fund said most investors looking at the region consider it from an asset allocation perspective, taking a view on whether to own region or not.
“The problem with that is that a lot of the big picture perceptions are not great ones,” Walsh explained. “Think of the last time you saw EU flag fluttering on the 10 o’clock news and – Ryder cup aside – you expected something positive to come next.”
In reality, he said, a lot of the rhetoric tends to focus on other factors such as issues of national protectionism and bureaucracy in the EU.
More recently Brexit has been another stumbling block for the region while Italy is also in the headlines over its confrontational relationship with the EU.
“There is a lot of negative dialogue and this overall perception of Europe as this creaking, old continent that is lumbering steadily from one crisis to the next,” the manager said.
Away from macroeconomic factors, he said, investors have largely been focused on growth and in particular technology.
However, this is an area where the European market is largely lacking, with Amazon or Google in the US and Tencent or Alibaba in Asia dominating the tech space.
Performance of indices over 10yrs
Source: FE Analytics
Walsh said: “These companies tend to be seen as carving up the global economy between them and the question is where is the European equivalent?
“We struggle because most of the big companies still within the European market are more traditional businesses operating in more traditional industries.”
Indeed, this may help to explain why the European market has been somewhat left behind over the last decade, with the MSCI Europe ex UK lagging the wider MSCI World index by 96.77 percentage points, as the above chart shows.
Many of these companies tend to be in industries that have struggled over the last decade, such as the healthcare or financial services industry.
“Frankly their track record in the past is not great in terms of creating value and the prospects for growth in the future are not great either,” he said.
“People look at the big picture and when they come back they get some pretty negative messages and that is quite a hard starting-point to come from.”
However, he added that this is “absolutely the wrong way to approach European investing” as there are a number of companies within the sector that can outperform.
Indeed, the below chart shows the average five-year returns from companies with a market capitalisation of more than £1bn over the last 30 years.
The distribution of returns in Europe is very similar to that of the US – somewhere that investors might expect to have many more companies making large returns.
Five-year stock return distribution of £1bn+ stocks 1987-2017
Source: Baillie Gifford
“The odds of doubling your money in a stock over five years for both markets is around 30 per cent,” Walsh said.
“It is not just in America or other markets where you find these big winners. There are plenty of companies delivering exceptional investment returns if you know how to find them.”
What these companies tend to have in common is that they operate in large or growing markets with strong competitive positions – meaning they can achieve growth without detracting from returns for shareholders.
“They also tend to have pretty strong cultures and good alignment between management and their shareholders,” he noted.
In the £451m Baillie Gifford European fund, which he runs alongside Stephen Paice and Moritz Sitte, he looks for three different buckets.
The first are top consumer brands – something which Europe is known for.
“Richemont – which is the owner of Cartier – Adidas and Nestlé: these are fantastic businesses that are very well-known,” he said. “They have a tremendous heritage and operating capability that makes them very hard to disrupt.”
While he does own these within the fund, they are also well-known to the market, meaning that they can trade on richer valuations.
The second group is ‘hidden champions’, which are companies that tend to operate outside of the news flow but that, under the radar, are able to provide big returns. These companies, often in unglamorous industries, also tend to share common characteristics.
“These are not consumer brands – they are businesses that the average person on the street has never heard of that tend to be owned or managed by insiders – so people who have a stake in the business and therefore understand the importance of long-term value creation,” he said.
“They tend to be well known by tradesmen or professionals which builds a bond of trust and enables them to build up dominant market shares in niche markets.”
The third area he finds companies that have the potential to make strong returns are from disruptors – albeit that there are less than in the US.
While there is no Google equivalent, Spotify has become the flagbearer for Europe as a business that has emerged as a global champion, he said.
The world’s leading global subscription-based model in the music industry is now listed in the US but originated from Sweden.
“It has shown you do not need to be in Silicon Valley in order to build a global giant and they are not the only one. They are emblematic of a start-up culture that is developing and evolving in Europe,” he said.
“The FT says that we don’t have as many unicorns in Asia or America and that is true but that does not mean we don’t have great companies emerging.
“We have maybe been a little bit behind the curve but you are starting to see the emergence of business like this across Europe – especially in Sweden and Germany and I think this is the start and you will see more of these come to market in years to come.”
Performance of fund vs sector and benchmark since manager start
Source: FE Analytics
Baillie Gifford European has been a top quartile fund in the IA Europe ex UK sector over three, five and 10 years. Since Walsh joined as co-manager in August 2015 it has returned 50.89 per cent, beating the sector average and MSCI Europe ex UK index by 23.81 and 25.31 percentage points respectively.
The fund has a clean ongoing charges figure (OCF) of 0.59 per cent.