Every cloud has a silver lining
Whilst there seem to be few reasons to be cheerful about Europe, if you know where to look, there is much to be optimistic about. A confluence of internal events is driving change in the region, combining political, economic and social factors. At times, these changes can be concerning: the development of nationalistic politics, low economic growth (versus the US and Asia), the end of quantitative easing by the European Central Bank, Brexit, and the social upheaval of immigration are all causing investors to step back and watch from the side-lines.
Weekly outflows for European stock funds ($m). Sources: EPFR Global, FT, Bloomberg, 05/05/2019
Regional worries are also compounded by an uncertain global outlook. As Chinese growth falters (2018 growth was the weakest in 28 years), its appetite for materials and consumer goods shrinks. China's trade war with the US is painful for both countries and local clashes worldwide further cloud the picture, with Tweets from world leaders hindering the smooth flow of commerce.
There are also social changes to consider: how we communicate and interact, how we address environmental concerns, and the move towards responsible citizenship. These trends alter the consumer landscape. Countries, sectors and companies must adjust to these changes and adapt to the structural trends shaping an increasingly globalised world: an ageing population means a declining workforce, millennials are adopting different values to their predecessors, and persistent migration puts pressure on infrastructure.
The result? Increased global market instability, higher risk premiums, and a further polarisation of performance that make investment opportunities harder to identify. But does that mean investors should write off Europe and its markets? We think not.
Finding the diamonds in the rough
Carmignac's Head of European Equities Mark Denham sees the opportunities in this unloved geography - he is convinced of Europe's potential. Denham is a stock picker who understands businesses from the bottom up and selects companies for their individual characteristics and prospects, rather than taking a regional top-down view or emphasising sectors. "There is always something happening" he says. "As an investor, and especially as a stock-picker, you need to find the diamonds in the rough - and Europe has plenty. It's more a matter of finding them."
As such, Denham follows a simple philosophy: he focuses on companies that can demonstrate high and sustainable profitability and reinvest profits internally for future growth. "Whatever the background, I will always look for companies which can grow under their own steam and are less reliant on the economic background to generate good long-term returns," he says. Being socially responsible is an important factor for good long-term prospects, and Denham therefore integrates this thinking within his investment process:
"I think it's a mistake to consider ESG or SRI as a separate part of the process, as it is as important as financial criteria in assessing which businesses have the best long-term prospects."
Sector allocation is therefore driven by stock-picking, rather than the opposite: "We have no sector bias, we can invest in the pharmaceutical sector or the industrial and consumer arena, wherever our investment process brings us." Denham's selective criteria and sustainability filters naturally encourages him to invest in innovative companies. "The world is now changing at a pace never seen before. In the past, companies could follow the same strategy for 30 years. Those days are gone, industries need to change fast, at least as fast as consumers' preferences are changing if they want to stay in the game."
According to management consultancy Bain¹, companies that perform well in innovative initiatives grow significantly faster than lesser performing companies, gaining a three-fold difference in five years (84% for top innovating companies vs 28% for the others). "Innovation is critical for future success," says Denham. "And when we talk about innovation, we do not only mean technology."
He believes innovation can come in many shapes and sizes - often tech is just the enabler - and the diversity of sectors where innovation is taking hold is bigger than we may think, offering a great selection of opportunities. "Counter-intuitively, we find lots of very innovative companies within the industrial sector," says Denham, who has invested in firms such as Assa Abloy (see investment case below) and Vestas.
¹Top innovating companies refers to companies with top quartiles scores in the Bain Innovation Assessment Survey of executives at enterprises around the world.
PORTRAIT: MARK DENHAM
Mark Denham is Head of European Equities at Carmignac and Fund Manager of three European strategies, of which the recently launched OEIC fund, ‘FP Carmignac European Leaders', specifically designed for UK investors. It is a high-conviction, concentrated fund with a low turnover, which seeks to achieve capital growth over a minimum of five years by investing in continental Europe and through a disciplined and socially responsible investment process.
Denham joined Carmignac in June 2016 from Aviva Investors, where he was Fund Manager and Head of Pan-European Equities. Before joining Aviva Investors in 2003, he occupied various roles including Director of European Equities at Insight Investment and Fund Manager at National Mutual Life. He graduated from Cambridge University with a degree in Natural Sciences and holds a Postgraduate Certificate in Advanced Mathematics.
Investment case: Assa Abloy
Assa Abloy is the world's largest lock manufacturer. It makes a range of mechanical, electrical locks, as well as more sophisticated personal identification and entrance systems. The firm naturally meets Denham's financial criteria but what interests him about Assa Abloy is that it is a great innovator. It constantly rejuvenates its product suite.
The firm has a target whereby 25% of its sales must come from products launched in the past three years and it spends significant amounts in research and development (R&D). This inventiveness is consistent too: in 2018 the US business magazine Forbes ranked Assa Abloy as one of the world's 100 most innovative companies for the fourth time.
The firm's most recent innovation is the "smart lock", which lets you lock or unlock your house or office door remotely, using a mobile phone, for example. Assa Abloy entered into a partnership with Amazon, enabling customers to receive their delivery packages when they are not at home (see image). This innovation creates a huge market opportunity, as nearly 40 million Amazon Prime users can now use the service if they choose to.
