Bertrand Faure, portfolio manager of the Strategic European Smaller Companies Fund provides an update on the Fund’s strategy as well as his insights regarding the market corrections of 2018 and the drivers of strong returns during 2019.
Recorded: Monday, 17th June 2019.
The transcript of the interview is provided below:
What is the strategy and philosophy of the Fund?
Bertrand Faure: We have been managing money since 2002 through a long-short vehicle. Since 2015 the Strategic European Smaller Companies Fund is a Euro-denominated strategy with a special focus on European small and midcaps.
The universe has been screened since 2002 with no deviation. There are more than 800 companies in a proprietary database and more than 500 individual face-to-face meetings that are taking place every year.
The fundamental analysis is coupled with an in-depth industrial approach and we tend to apply due diligence and valuation methodologies that are derived from the private equity market.
We like to wait patiently for the market to present opportunities to deploy capital in great businesses at substantial discounts to their intrinsic value.
We hold core position for years and we shift waiting to reflect the changes in risk reward profiles. We want to run a concentrated portfolio of approximately 30 positions and this is done through a team of six professionals which has been very stable throughout the years. Three of them are investment professionals, one is a trader, we have one admin director and one investor relations person.
Have there been any adjustments in the strategy since the Fund’s inception?
No adjustment was made to the approach and we stick to the idea that the free cash flow remains the best protection in the long run for equity owners. This will be even more the case should interest rates turn south as anticipated.
How did the market correction impact the Fund after a difficult year in 2018?
The Fund lost slightly last year constituting the first year since inception that the Fund underperformed its benchmarks so significantly over the past 17 years. Dichotomy of value versus momentum during the first nine months of the year, whereas fear prevailed during the last three months with strong liquidity crisis. Not only in the equity space, but more importantly in the fixed income environment also.
Economic and political fears like deleveraging in China, political issues in Italy, trade wars, yellow vest protests in France, Brexit and the slowdown in Germany, triggered massive outflows from European equities. Market didn’t discriminate.
Investing based on fundamentals didn’t work last year. Mersen, for example, with EPS expectations increasing by 45% so its stock price dropping by 37% during the year. Even non-cyclical companies were heavily sold off, such as Albioma, a green energy producer with regulatory returns.
What are the drivers of the strong returns delivered in 2019? Are they sustainable over the short to mid-term?
Following the shock of Q4 ‘18, the past five months delivered some of the best returns for a long time. The Fund is up approximately 15% year to date and from a broader point of view one of the stories that characterized ‘18 was the total absence of positive return in any major asset classes.
So far, 2019 has been the exact opposite with healthy returns in commodities, stocks, credit market and fixed income. This phenomenon may appear counterintuitive in the context of continued uncertainties around Brexit, global trade agreements and the relentless slowdown in global manufacturing data driving EPS expectations down globally.
All of this was overshadowed by the change of tone from the major central banks. The market has been remarkably resilient with investors brushing aside bad news and buying on weakness.
From a top down perspective, the recent dovish statements by the Fed and the ECB clearly illustrates their willingness to remain flexible.
Important to mention that the rebound in European financial markets took place in extremely thin volume and still in the context of heavy redemptions. In the past 66 weeks in Europe, 64 of them experienced net outflows. The pause in monetary policy tightening should support the market globally for the months to come, as equity remains the choice by default and the only potential for value creation going forward.
What is your view on the current macro environment?
In spite of the recent U-turn in the U.S. China trade negotiations, our scenario does not believe there will be a large-scale confrontation between the two countries. As the two economies are too intertwined to keep up the trade war rhetoric. However, this change of course fuelled short-term volatility, consistent with our prediction at the end of April. Again aggravated by the continued outflows from the European equity space.
Have you implemented any changes in light of the volatility experienced?
The prevailing and continuing uncertainty means corporates are adopting a wait-and-see approach, which slows down capital spending and preventing M&A transactions, in spite of historically low interest rates.
Across the board, Q1 reporting was okayish in Europe with Q2 appearing to be more difficult. There are projects, there are quotes and requests around, but so far they failed to convert into real orders. Most corporates anticipated a back-end loaded year and this is certainly now the case more than before.
Against this backdrop the cyclical share of the portfolio was reduced to concentrate on investments more resilient and less sensitive to short term GDP fluctuations. We have also increased the cash portion of the portfolio to raise it to 20% approximately since the end of April.
What are the Portfolio’s two largest positions and their business case?
The Fund’s largest position over most of ‘18 and ‘19 has been Albioma, representing 8.5% of the Fund’s asset today. It is an independent energy producer, developing and operating projects in thermal biomass and solar power mostly in French overseas territories where it often represents more than 50% of the electricity produced on those islands.
Its returns are guaranteed by the regulator and thanks to the regulatory push all facilities should be converted to use renewable fuel sources in the future. Excluding growth cap ex on which Albioma also benefits from the same guaranteed return, free cash for yield stands close to 15% per year. And we see more than 50% potential for these investments from here.
Spie is the second largest position with 7.5% of the AuM. It is an independent European provider a multi-technical services providing installation and maintenance for electrical, mechanical, HVAC, IT and specialized energy services. Only with maintenance and backlog 85% of the annual turnover is already guaranteed on January 1st, providing an exceptional visibility.
In spite of 34% return this year stock still trades at a 12% free cash flow yield showing how undervalued it was on January 1st. Here also we see a potential of more than 50% which is generally what we see as an upside for the investor share of the portfolio.
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The views and statements contained herein are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the E.I. Sturdza Strategic European Smaller Companies Fund as of 17/06/2019 and are based on internal research and modelling. This does not constitute independent research and under no circumstances should the information contained therein be used as a recommendation to buy or sell any security or financial instrument or service or to pursue any investment product or strategy or otherwise engage in any investment activity or as an expression of an opinion as to the present or future value of any security or financial instrument. Nothing contained in the views and statements by Pascal Investment Advisers SA are intended to constitute legal, tax, securities or investment advice. The views and statements contain “forward-looking statements”. All projections, forecasts or related statements or expressions of opinion are forward-looking statements. Although Pascal Investment Advisers SA believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct, and such forward-looking statements should not be regarded as a guarantee, prediction or definitive statement of fact or probability.
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