From the February 2014 issue of Investment Advisor • Subscribe!

On the Mend: Europe’s Move to Recovery

Investors eyeing Europe have reason to be optimistic, even if they have to wait a little while longer

Photography by Jason Alden. Photography by Jason Alden.

“Broadly speaking, we think Europe is past the worst.” That’s reassuring news for investors interested in European equities. While there are still caveats that advisors should keep in mind, Stephen Peak, director of international equities for Henderson Global Investors and manager of the European Focus Fund (HFEAX), is optimistic about the region overall.

“At the moment, we’re showing clear signs of recovery, certainly from where we were a year or two ago,” Peak told Investment Advisor in December. “There are really strong pockets and signs and signals across Europe here and there—not universally, there are still some issues to be certain—but Europe is in recovery mode.”

That move to recovery will become more evident throughout 2014, Peak said, but he was careful to note that it won’t happen quickly. “Over all, we have to be realistic. We’re not going to get back in a hurry to the traditional growth rates that we became used to leading up to the global financial crisis. We’re still in a lower growth environment. Nonetheless, we think that growth is going to have more recovery, and we think the evidence will be clearer as we travel through 2014.”

Peak was reluctant to call any particular region in Europe off limits. “Geographically, there are no no-go areas because even in the roughest of times for individual areas—if you go back a year or two to Southern Europe, when everybody thought Southern Europe was pretty much a no-go area for fairly obvious reasons—you can still find individual stocks where the market was throwing the baby out with the bathwater.”

However, there are some sectors that advisors should approach cautiously. One that has some promise but requires advisors to remain selective is the financial sector, according to Peak.

“The U.S. banking sector deserves credit for doing a pretty good job of recovery,” he said. “Europe is not quite there. It’s going through that process where banks have to restructure, sell off non-core assets and raise more money on occasion. We think that process is ongoing, and we think European recovery probably plays hand in glove with the better tone for the financial sector. Good selectivity for financials will be important in the year ahead.”

Resource-related companies, particularly those that deal in metals, are another area where Peak is treading carefully.

Reiterating his point that Europe is looking at recovery, he said the region has been getting more interesting. “The previous winners in Europe if you go back—not this year but certainly over the last few years—have been the high-return companies, typically the consumer staples companies, those with exposure to emerging markets. In other words, the best recipe was to find equities with as little to do with Europe as you could possibly find because Europe is dull and the rest of the world is more interesting. Clearly, 2013 has seen a switch around of that. We’ve oriented the portfolio to have a bit more European sensitivity, shall we say, in terms of the geographical profile of our holdings.”

Looking ahead at 2014, Peak said that for some of those former winners, “in some cases the negative price action has gone a little bit too far. There will be some interesting, almost contrarian plays being presented to us next year, and clearly the ability to select halfway decently will be important in terms of performance. Trying to keep on top of those and get our timing and judgment correct is going to be pretty much the deciding factor for a successful 2014.”

Another source of opportunity in 2014 will be mergers and acquisitions, Peak said. “We’ve seen a number of interesting, big deals. The IPO market in Europe has been picking up a little bit. We have had suppressed M&A for a while in Europe, but I think the signs and signals are that it is picking up. That will probably create some additional opportunities for investors.”

The European Focus Fund invests in public companies in both the U.K. and on the continent, Peak said, with three very simple objectives: “One is to make some money for our clients. The second one is to beat the market; in other words, justify being active. And the third objective is to beat the competition. If we can do all three, then I think everyone will be thrilled.”

While the markets aren’t entirely cooperative yet, the fund has performed well lately. As of Jan. 10, the fund’s one-year return was 34.78%.

“We’ve managed to get more things right than wrong this year,” Peak said. “At the end of November, the fund was up about 30% in round numbers, and that compares to the MSCI Europe up about 13%, so significant outperformance for the year. Longer term, we’ve had a very good 12-year record. We clearly rank in the top decile of the category. It’s a record I’m very proud of. As they say, the past is no guide to the future, but we want to obviously keep the credentials of the fund intact.”

Peak said he follows three principles in managing the fund. “No. 1, this is a bottom-up fund. No. 2, it’s really a blend style. There’s no significant growth flavor; there’s no significant value flavor. It’s a blend of best ideas. And the third building block is we have the ability to go all-cap.” Peak looks at and invests in the “very biggest companies” all the way down to small-cap firms “when the time is right and the opportunity is right.”

“The overall idea of this fund is we appreciate that in the American market, clients are never going to have two, three, four, five funds in Europe. They’re probably only going to have one,” he said. “So if we have a fund that has the ability to be an all-weather fund rather than something that only performs when value is in or when growth is in or when small-cap is in, clients can hold this. It’s a multi-year hold, rather than something where they need to worry about the seasonality of the fund or the style of the fund.”

At almost $720 million in assets as of Jan. 8, Peak called the fund “a good size” and expects it to continue growing as more U.S. investors are attracted to Europe. “The U.S. has been a great place to be, but it’s trading at all-time highs, and we think there are more opportunities outside of the United States. International markets and Europe in particular [are playing] catch up to the relative economic success that we’ve seen in the U.S. On the back of that, Europe’s high was back in 2007; to get back to that high, the markets would have to move up 30%. That doesn’t mean they will go up 30%, but it’s an interesting contrast to the domestic equity success that American investors have enjoyed. I think it’s a good argument for diversification. Beyond that, there’s a very good investment return argument that we would encourage clients and their advisors to think very hard about in terms of their mix of exposure. We’d argue for more international and less domestic.”

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