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Portfolio > Portfolio Construction

European Recovery Focuses Attention on Cyclicals

By Savita Iyer-Ahrestani

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European cyclicals have grabbed the attention of many investors who are bullish on European recovery following the economic crisis and Dale Winner, co-manager of the Wells Fargo Advantage International Equity Fund, counts himself among them.

Risk has greatly reduced in Europe, Winner said, and GDP is on the upswing even as corporate capital expenditures in the Eurozone are still at a 20-year low.

As such, “we want to be involved in European cyclicals, but we’re not sure how the cycle will go and when it will really take off, which is why we’re focused on what we call ‘self-help cyclicals,’” said Winner, who is also co-portfolio manager for the EverKey Global Equity team at Wells Capital Management.

Self-help cyclicals are companies that in the wake of the financial crisis took it upon themselves to “get their houses in order,” Winner said, in order to become stronger and more competitive players in a global market. They are now poised to take better advantage of the recovery when it really gets going.

German engineering and electronics behemoth Siemens is one of the best examples of this, he said.

“We compare Siemens to GE in the U.S., even if its margins are much lower, because it was such a huge conglomerate with a bloated cost structure,” Winner said. “But a new CEO has totally reshaped its portfolio, by, among others, exiting low return businesses and by selling Siemens’ telecom network, NSN, and then returning cash to shareholders. Siemens also has a three-year plan to increase margins from nine percentage points to 12 percentage points, which is a great way to fine tune a bloated cost structure.”

Winner has owned Siemens for two years now, and although it is trading at a 20% discount to its competitors, the aggressive measures taken by the CEO mean that “its margins will get closer to its competitors and we’ll have 65% to 75% upside returns from here on,” he said.

Ditto for global paints and plaster giant Akzo Nobel, another company hurt during the crisis but that used the down time to aggressively reshape its business. Today, Akzo Nobel is a very different company than it was prior to the crisis, Winner said, and is well poised to benefit from a recovery in European cyclicals.

Winner co-manages the Wells Fargo Advantage International Equity Fund with Jeff Everett, former president of Templeton Global Advisors and founder of EverKey Global Partners, where Winner also worked. In 2012, Wells Fargo purchased EverKey and the EverKey investment team took over the then-ailing Wells Fargo Advantage International Advantage Fund. Since then, the fund has been beating its benchmark.

Winner credits much of his team’s success to its investment approach, the bedrock of which lies in a strict, three-tiered risk management process.

The process starts with an analyst, Winner said, who looks at a company’s risk-adjusted returns and assesses upside versus downside using historical valuations. After that, EverKey’s dedicated risk manager, Venk Lal, is in charge of determining absolute risk and assessing “our net exposures on a portfolio level and how are current exposures are poised for intended and unintended risks,” Winner said. “We took the view, for instance, that there was good upside and not much downside in Japanese equities but we were very nervous of the Japanese yen, so we were able to hedge that, and though we have a 25% exposure to Japan, we have overweighted our yen position. This is how we actively manage risk.”

The third and final level of risk takes place at the Wells Capital level, “where our weightings are assessed relative to our benchmarks and to our peers,” Winner said.

This particular approach resulted in a reduction of 40 names in the International Advantage Portfolio to a current total of 60.

“We have no problem taking on risk,” Winner said, “but getting paid for that risk is what’s important to us.”

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