Three Bridges Capital’s Europe Fund, after reporting +25.9% returns in 2013, the fund’s best performance since its founding in 2006, is even more enthusiastic about investing in Europe in 2014.
Looking back on 2013, the fund’s long / short strategy was able to pick apart different sectors of the European stock market. “Sector performance across Europe varied considerably as the Travel & Leisure, Financial Services, Insurance and Media sectors produced positive returns, while declines came across a number of industries including Retailers, Real Estate, Utilities and Household Products,” the fund said in an investor letter reviewed by ValueWalk. “In contrast, stock picking within the portfolio delivered good uncorrelated gains as strong profits from positions in Industrials, Telecom and Financials more than offset modest declines from a small number of positions in Utilities and Energy for the month.”
The strategy of Three Bridges Capital is one of relative value. With $542 million under management, the fund purchases stocks it believes are undervalued and sells stocks it believes are overvalued. Typically the fund is overweight to the long side by an average of 67% more than the short side. It is what the fund sees on the long side in 2014 that is most interesting.
“The storm clouds that have been hanging over Europe for the past six years have finally lifted,” Gene Salamon, the fund’s managing partner and CIO, said in an opinion piece he published on the web site Fin Alternatives. “Macro-related risk fears are moderating and a gradual recovery continues to progress. Yet as a whole, European equities are still at depressed levels, creating an exceptional opportunity for investors.”
Mr. Salamon appears sanguine regarding the structural fundamental damage caused by the 2008 market crash and any potential European debt crisis.
“Sensational news coverage in recent years, and perhaps the recent experience with the U.S. sub-prime crisis, led investors to extrapolate those concerns into the excessive tail risk fears we saw during the past four years, particularly in 2011 and much of 2012,” he wrote. “With macro tail risks reduced, the bearish view on Europe should be reversed. Our firm opinion is that the opportunities offered by European equities have never been better, particularly for fundamentally-focused stock pickers.”
European debt crisis vs US and Japan
The debt crisis has been the unspoken elephant in many rooms among institutional investors, but Mr. Salamon isn’t fazed, making the point the problem is with the periphery countries and Europe is better off than the US and Japan.
“Although the term ‘European debt crisis’ has frequently hit the headlines, the reality is that from the beginning, the crisis in Europe generating those scary headlines has been a sovereign debt issue in the periphery of Europe. Aside from the periphery, Europe does not have a sovereign debt problem. Europe, even including the periphery, has lower debt and smaller deficits than both the U.S. and Japan. The core European economies have relatively favorable ratios of government debt to GDP and deficits as a percentage of GDP compared to other regions. We believe that the issues in Europe are more political in nature than economic. The real challenge for mainstream Europe has not been deficit reduction but finding the political will to build a structure that is properly equipped to deal with the difficulties faced by the peripheral countries.”
Relative value Europe vs US
Mr. Salmon breaks down European opportunity from a value perspective, which is where the relative value opportunity to US investing is compared. “Fear over macro events in the periphery of Europe has created a disconnect between current stock valuations and corporate fundamentals. European equities have underperformed the S&P 500 but now valuations in many cases look highly attractive. Whereas MSCI Europe trades on a price/earnings ratio of less than 11x, the S&P is at 16x. Dividend yields are at unprecedented high levels compared to corporate bond yields. Nearly 50% of European companies have dividend yields (in most cases well covered) in excess of their current bond yields.”
Sounding ever the evangelist, Mr. Salmon remains resolute in his investment thesis. “European equities represent approximately 30% of global equity markets, yet many investors have largely abandoned or under-allocated to the region,” he wrote. “The de-rating of Europe in recent years has created an unprecedented disconnect from fundamental factors. With macro tail risks reduced, the bearish view on Europe held by most investors should begin to reverse.”