June 7, 2004 — The ICAP Funds:European Select Equity Fund (ICEUX) invests overseas, but it judges stock prices by comparing them to an American equity market gauge, the Standard & Poor’s 500-stock index.
Lead portfolio manager Rob Lyon and Matt Pickering hunt for European companies whose shares they consider inexpensive relative to the S&P 500 and their industry peers. Pickering joined Lyon on the fund in 2000.
Overall, Pickering describes the fund’s holdings as “a stable group of large, blue chip, multinational companies,” that as a rule generate “average to above average” returns on equity and capital. The managers also favor businesses with strong cash flow and low debt. When everything else is in place, they scan for a catalyst, like a new product, that can spark growth.
The two stock pickers limit their portfolio to 20-25 stocks. Not many companies have the financial characteristics they prize, says Pickering, who adds that the narrow focus facilitates research and enables winners to make maximum contributions to the fund’s performance. “We’ve found that it allows us to deliver the best risk-adjusted returns for our clients,” he says.
The $57-million ICAP European Select Equity was one of the ten best performing European funds during the one and five years ended in April, and it’s expenses were among the lowest in the category.
The ICAP fund returned 38.8% and 2.7%, respectively, for the one and five-year periods, versus 35.7% and 1.9% by its peers. The fund sports a very low expense ratio of 0.8%, versus 1.93 for all 120 European funds.
Pickering cites Vivendi Univl SA ADS (V) as a typical investment for the fund. Paris-based Vivendi started life as a water company and has transformed itself into a media and telecommunications power.
Former chairman Jean-Marie Messier had made acquisitions that saddled Vivendi with debt. But his successor, Jean-Rene Fourtou, who came on board in 2002, has “done a good job” of selling off non-core operations and lowering liabilities, Pickering says.
In its first quarter report on May 27, Vivendi said it had net debt of about 7 billion euros ($8.5 billion) — down from 11.6 billion euros ($14 billion) two months ago thanks to the recent sale of its U.S. entertainment division to the NBC unit of Genl Electric (GE).
The fund bought Vivendi in February. At the time, the managers felt its assets were priced too low in comparison to its assets, especially since it was shedding debt, Pickering said.
In April, the managers invested in BASF AG ADS (BF), a German chemicals maker whose stock struck them as undervalued. The company’s attributes, Pickering says, include its oil and gas business, which “generates a nice, steady profit stream.” BASF buys natural gas in the summer, when prices are low, stores it, then sells it for higher prices in the winter, he explains. In addition, BASF’s basic chemicals operations have been enjoying pricing power of late, he says.
The fund’s No. 1 stock is Royal Bank of Scotland. The Edinburgh-based financial services company sports returns on equity in the high teens, and has been able to generate asset growth at a mid-teen to low 20% pace per year, Pickering says. That in turn supports “solid, low double-digit” profit growth,but the stock still trades for only about 10 times projected 2004 earnings, he says.
Another financial services giant, ING Groep ADS (ING), holds second place in the portfolio. Pickering likes the Dutch company because of its large European investment banking business, which he says it is restructuring in an effort to boost returns. The company also stands out because of its life insurance business in Europe and the U.S., where it is among the top players, he says. Beyond that, Pickering thinks ING should benefit from the improving U.S. economy and stock market.
When it comes to selling, the managers will trim a stock or eliminate it from the portfolio if it becomes pricey, or if a company’s financial fundamentals start to slip.
The failure of a catalyst can lead to a holding being banished, too. For example, the managers sold Atlas Copco, a Swedish industrial concern whose businesses include rental operations, because that unit’s U.S. business did not pick up as expected, Pickering says.
The fund tends to overhaul its portfolio more often than its competitors. ICAP European Select Equity had a turnover rate of 218% last year, compared to its peers’ 136.7%.
In making a case for investing internationally, Pickering maintains that foreign stocks that are comparable to U.S. blue chips are more reasonably priced than them. “Despite the fact that equity investing has increased in Europe, we still see valuation discounts,” he says.
Contact Robert F. Keane with questions or comments at: