Four different ways to invest in Europe
This article first appeared on professionaladviser.com on 2nd September 2022 “When has Europe ever...
Chunky heels, bomber and leather jackets… a quick look through the latest fashion trends of 2022 and you could be forgiven for thinking we’re back in the 80s or 90s. Fashions come and go with amazing regularity, and not just in the world of clothing. The same can be seen in the world of investments and being out-of-fashion can have dire consequences when it comes to your finances.
Take the growth vs value argument as an example. For much of the 2010s, growth stocks – those companies whose earnings are growing quickly and whose future cash flows are considered especially valuable in a low interest rate and low growth environment – did much better than value stocks. The latter are companies that are unloved and valued cheaply for one reason or another, but which have the potential to bounce back.
The pandemic further fuelled growth stocks, throwing up a series of big winners, whose hare prices rose exponentially – think Netflix and Zoom among others.
But as we emerged from Covid-19, the clouds gathered for growth stocks. Not only did traditional value areas such as energy, financials and commodities become popular, but easy money, pent-up demand, and supply chain issues them in a way last seen in the tech bust and the Great Financial Crisis. Value stocks soared, while growth stocks plummeted.
According to Baillie Gifford, which has several funds Elite Rated by FundCalibre, including Scottish Mortgage Investment Trust, the sell-off has been indiscriminate and some growth stocks are in significantly better shape than those damaged during earlier crises. “The volatility of share prices of growth stocks has been both staggering and sobering,” the company said in a recent update. “It has been a humbling experience for managers such as Baillie Gifford and more so for our clients. Indeed, we are acutely aware that 2022 has been very uncomfortable for those that invest with us.
“As a result, we have revisited the investment case for every stock we hold. We are gauging their long-term prospects in the prevailing environment and beyond. We are more than happy to continue holding most; some are in the waiting room, and a few have been shown the door.
“We could be on the cusp of a great opportunity,” the company continued. “Netflix and Zoom have seen share prices fall back below 2019 levels. This is despite revenues and margins doubling in the case of the former and revenues multiplying by five for the latter. The much-maligned China tech giants Alibaba and Tencent are priced at 2016 and 2017 levels. Again, despite revenues increasing five times and doubling respectively. Significant operational progress and savage ratings creates market inefficiency and therefore opportunity.
“Another key difference between the growth of today and yesterday is its resilience, especially in the face of reinvigorated inflation. In many cases, the stocks held in our portfolios are growing sales faster than before Covid-19. This suggests customers value their products and they have pricing power. These growth companies have net cash on their balance sheets, or at least positive free cash flow. They are busy investing in their future, not maximising profits in the present.”
John Bennett, manager of Janus Henderson European Selected Opportunities fund has a different view. “I think we’re still in the foothills of value outperforming growth,” he said in a recent update. “, I think we’ve got to be a bit careful. It’s dead easy in this business to be binary and the value/growth debate is part of that. And I don’t think all value has been outperforming and nor will it outperform. For example, the favourite poster child sector for value historically was banks but I don’t think you’re going to get too much durable outperformance from them. You’ve got to be choosy even in value.
“But I think growth stocks are broken. And what broke them? You had a change in the cost of money. It went from ‘free’ to costing something and that has broken hypergrowth – all those not-for-profit so-called digital disrupters. It’s sheer nonsense. But the less nonsense part of growth is also broken. And what I mean by that is long periods of outperformance has broken, that trend has now ended.”
Ian Lance and Nick Purves, co-managers at RedWheel, agree. In a recent interview they said they believe the current market has eerie echoes of the 1970s, with inflation soaring due to an energy crisis and popular high-growth stocks taking the brunt of rising interest rates.
They cite the example of the 1960s, when a group of US growth stocks including names such as IBM, Xerox, Polaroid, and McDonald’s, or the ‘Nifty Fifty’ as they became known, were considered “one-decision stocks that you buy and hold for life”.
Ian says that these highly valued stocks captured investors’ imaginations much like the Faang stocks in recent years – Facebook, Amazon, Apple, Netflix, and Google-owner Alphabet. However, these stocks – just like the big tech giants today – fell heavily as inflation started to soar in the early 1970s. Nick added that, in contrast, value stocks performed well coming out of the 2000 tech bubble, the global financial crisis and the pandemic, and he expects the current crisis with the war in Ukraine to follow the same pattern.
In her Q3 outlook, Fabiana Fedeli, chief investment officer of equities & multi asset at M&G Investments, cautioned that “This is a market that is defying traditional stereotypes, blurring the lines between the common definitions of growth, value and even what constitutes a defensive stock.”
“Following the sell-off in the technology sector, we have seen stocks that had traditionally been part of growth indices move to value indices,” she said. “This has been the case in both developed and emerging markets equities. For some stocks, the move was a full transfer, while other stocks are part of both value and growth indices.
“All of the above implies that, in this market, we need to adjust the traditional mindset of looking at equities in broad buckets. Focusing on traditional definitions of ‘value’, ‘growth’, or ‘defensive’ stocks and only looking at an index or sector level, rather than at individual stocks, may lead to overlooking companies with strong fundamentals where valuations have been hit indiscriminately, or conversely, could lead to blindly believing in the ability of a company to withstand the macroeconomic headwinds solely based on its past ability to deliver a stable and visible earnings path (and in a very different environment).”
FundCalibre always suggests having a blend of styles in a portfolio to ensure diversification. But the other alternative is to invest in a fund that is style-agnostic, or which invests in all types of company.
Janus Henderson European Smaller Companies fund is one such example. It is a pure small-cap vehicle which has a ‘style agnostic’ approach to investing. This means the managers will buy growth companies at a reasonable price as well as looking at neglected areas of the market.
The manager of Fidelity Global Special Situations meanwhile, does not stick too rigidly to one particular investment style. His investments fall into one of three buckets: corporate change – shorter-term investments which take advantage of corporate restructuring or initial public offerings (new stocks coming to the market); exceptional value – cheap stocks which have a potential to grow earnings; and unique businesses – companies with a dominant position within their industries, which should be able to grow for many years to come. Depending on which bucket they fall into, investments will be held for different lengths of time.
SVM UK Opportunities is another example, which has the flexibility to invest across the UK stock market cap spectrum and, while the fund has a value tilt, it is not beholden to a fundamentalist value philosophy – the manager will invest in growth stocks where he sees opportunity.