In January, the Strategic Europe Quality Fund declined by 8.10%, while the MSCI Europe was down 3.20%. The underperformance was evenly split between sector allocation (-2.61%) and stock selection (-2.33%). Our structural underweight in the Financials and Energy sectors cost us 181 bps over the month.
In the face of persistently high inflation, the market was priced in the likelihood of several rate hikes and rotated out of “long duration” names (Defensives and Growth) into Value, hence the structural overweight of the Fund to Quality dragged on relative performance.
Though our Value holdings were mostly resilient (e.g. Vinci, Stellantis), their performance was largely overshadowed by underperformance from a large portion of our Quality holdings (e.g. Kingspan, Croda, Bureau Veritas, Essilor Luxottica), with the latter affected by a sharp derating despite unchanged operating prospects.
These rotations are recurrent and do not call into question our belief that the economic performance of companies remains the primary driver of stock market performance over the medium and long term.
In light of this, we remain committed to the Fund’s positioning and strategy, and hence our moves over the period were mostly tactical:
• We slightly reduced the Growth exposure of the portfolio from 28% to roughly 22% at the beginning of the month to mitigate the rotation headwind, exiting Dassault Systemes and Teleperformance, with both names trading close to our fair value;
• We redeployed some of this capital to buy two new names in the same space towards the end of the month, building small positions in recently beaten-down stocks of exceptional companies: ASML and Sartorius (both down by more than 20% over 3 months);
• Among our Value plays, we pivoted out of Stellantis into more Defensive, disruption-free and inflation friendly Michelin. While we remain positive regarding the ability of Stellantis’ management to turn Fiat around, we are increasingly cautious about the prospects of the wider automotive industry. Though short-term supply headwinds may subside, so will the major price / mix tailwinds of recent months. With rising inflation, likely widening credit spreads, and a looming BEV transition/disruption, mid-term prospects for Auto profits are far from exciting.
On the valuation front, we take comfort in the current valuations:
• Given the repricing observed on many positions, our 12-month average price targets are currently around 20% above current prices, well above historical average;
• Some names like Bureau Veritas, Nestlé and Essilor Luxottica have already returned to current year P/Es identical to their 2018 levels, despite lower interest rates (3% in 2018 vs. 1.90% today) thus providing a good margin of safety.
Whilst we believe the rise in interest rates is justified by the higher-than-expected inflation levels, the ongoing repricing presents increasingly attractive entry points for companies with solid fundamentals and reasonable valuations. The backlash to rising interest rates could be a sharper-than-expected economic slowdown. The flattening of the yield curve may be the first indication of this. Such a scenario should be favourable for the relative performance of the Fund.
As always, we invite investors and prospective investors, to get in touch should you wish to discuss the positions held in the portfolio. Please do not hesitate to contact us for further information.
+44 1481 742380
The views and statements contained herein are those of Phileas Asset Management in their capacity as Investment Adviser to the Fund as of 07/02/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.