Fund Overview
The Fund seeks to achieve long-term capital appreciation primarily through investment in equities of European companies. Fund performance will be primarily derived from stock selection. Stock selection is based on an opportunistic approach with a flexible methodology on stock capitalization and growth/value orientation. The Portfolio Manager follows a ‘growth at a reasonable price’ philosophy, with a focus on investment opportunities which seek to maximize absolute returns irrespective of style. Country and sector allocation decisions are driven by the stock selection process. The Fund is managed by
Stephen Peak.
Quarterly Commentary
Volatility for all risk assets remained high in the third quarter, driven by news flow from the Financials sector. Credit markets continue to be very tight, with inter-bank lending rates at historically high levels and the Treasury Bill (T-Bill) rate at one point dropping close to zero, reflecting banks' unwillingness to lend to each other. Authorities have sought to alleviate the credit crisis through liquidity injections, restrictions on short-selling and most recently, and most significantly, the US Treasury's proposed bail-out program to purchase toxic assets from the nation's failing financial institutions.
Clearly, this is a very difficult environment for equity markets which have been sold off aggressively by investors as risk appetites have collapsed. After a solid first half to the year relative to the MSCI Europe Index, the Fund's performance has been very disappointing in the third quarter.
Fund performance review
The majority of the Fund's underperformance can be attributed to our exposure to resources-related names where we underestimated the speed and ferocity of the sell-off. We reduced our exposure to these names towards the end of the second quarter as we felt that slowing global growth would have an impact on commodity prices and we thought some profit-taking would be prudent. With hindsight, we clearly did not do enough and this has impacted performance.
In our view, the sell-off in the mining sector has been indiscriminate, as shown by the big drops in Centamin and European Goldfields which are both gold miners and should benefit from gold's potential 'safe-haven' status. Elsewhere, stocks have considerably overshot the fall in underlying commodity prices, particularly base metal miners like Kazakhmys and Lundin Mining. The copper price fell by around 25% during the quarter, yet these shares have fallen significantly further. The sector is trading on extremely low multiples even assuming lower commodity prices.
Energy holdings have also hurt the Fund. The biggest detractor has been Russian Natural Gas producer Gazprom, which has been impacted by both the falling oil price and geopolitical events in the region. We believe that Gazprom remains a compelling investment opportunity thanks to its unrivalled resource base and strong margin growth from surging domestic and European gas prices. The stock now trades at a 60-70% discount to its peers and we believe this represents a buying opportunity.
Our holdings in the Oil Services and Exploration and Production (E&P) sub-sectors have also hurt performance. The sub-sector is trading at historic lows – the last time it was close to this multiple, oil prices were around $30/barrel. We believe the long-term investment thesis is intact – i.e. these companies have potential to be beneficiaries of the need of the integrated oil companies to replenish their depleted reserves. We therefore do not intend to sell at what we believe are very attractive valuations.
In terms of positives, Fund performance has been helped by our euro and sterling hedges. Continued repatriation of US dollars by US investors and corporations over the coming months should provide further support for the dollar. Our underweight to the Financials sector has also been a positive this year as the sector has struggled.
Finally, our holdings in the media sector have helped relative performance. We bought into the sector in July as we felt valuations were very attractive, particularly for companies whose revenues are dominated by subscriptions and business journals.
Investments
We did not change the structure of the Fund particularly during the period, as we are confident in the fundamentals of the individual companies we own. In certain areas of the market we are seeing historically low valuations and do not believe that this is the time to capitulate.
Outlook
We are disappointed with the performance of the Fund in the third quarter, and intent on correcting it. We firmly believe that when investor confidence returns, and with it a potentially renewed focus on fundamentals, the underlying strength of the stocks in the portfolio may be rewarded by the market, but accept that patience is required.