Hermes' Tim Crockford on finding the mid-market diamonds in Europe's uncertain industries
To hear a European equity investment manager say that they wouldn't buy the European market would make most of us wonder if they were trying to come across as being ironic, or facetious. But Tim Crockford, lead manager of the Hermes Europe ex-UK Equity Fund, isn't. There are many reasons why he and his team take this view - most important is the way in which the European indices are constructed, even their own benchmark, the FTSE World Europe ex-UK. Tim, who became the fund's lead manager in 2015, points out that over one-fifth of this benchmark is comprised of European financials.
"And right now, we don't feel comfortable putting a fifth of investors savings in European banks for any long period of time," he states. Against a backdrop of economic and political uncertainty as well as central banks posing a systemic risk to the eurozone financial system, his point from an investment perspective is valid. These factors have led to substantial outflows from the region and throughout the globe investors have tended to underweight Europe as they wait to see how these issues play out.
The Hermes investment team believe European benchmarks, more so than their global counterparts, can mask some exciting opportunities that may present themselves in the region, but get lost amongst a sea of large but structurally challenged industries. The team considers one of the key opportunities in European indices to be the huge inefficiencies associated with what's big, and on the flip side, the glaring inefficiencies in terms of what isn't big, when it comes to classifying benchmark companies.
An alternative approach
The strategy for the Hermes Europe ex-UK Equity Fund is not about buying Europe; instead, the focus is on identifying particular European equities, completely missed or underestimated by the market, with the potential for positive changes to enable it to grow its capital, and its earnings, going forward. Effectively, the fund takes a style-agnostic approach, investing in the prospect of positive change, which can manifest itself in all corners of the market, and when it finds the opportunity, it invests actively and with high conviction.
The investment team refers to the fund as being style-agnostic in part because of how it purchases new ideas. It will invest in value, mid-cap companies with unrealised potential, which are gravitating towards becoming larger cap companies with their growth credentials recognised as their valuations grow throughout the holding period. "We look for stories that revolve around seeking change and unrecognised change, which leads us to corners of the market which would traditionally qualify as the value areas of the market, as well as those that would qualify as growth" says Tim. It will also buy growth companies.
This is because the team may detect something in a company that is trading on a typical growth valuation, but which they believe the underlying future assumptions - for cash flows and earnings - are underforecast. The fund concentrates mostly on companies with a market cap larger than €1 billion - mid cap companies. This is because the investment team believes there are some very exciting new stories in this space which are going to emerge as tomorrow's large or mega-cap companies.
The fund typically doesn't invest in giants because they infrequently offer an angle for unrecognised change. It also steers clear of micro-caps due to the lack of liquidity, nor does it buy into the deep cyclical space. This is because these firms are too dependent on the financial cycle for future earnings, and they are usually very capital-intensive businesses.
Click here to read more from Hermes, and where the investable opportunities are in Europe