Graham Clapp and Edward Rumble, former Fidelity fund managers who now run the $641.25 million (€475 million) Pensato Europa Total Return Fund, reported that while the year 2013 was a bright spot for Euro equities, 2014 will see moderation as earnings catch up with a buoyant stock market and the Fed continues with its tapering program
In a letter to investors reviewed by ValueWalk, Clapp and Rumble disclose a 1.57% return to investors in 2013, with a 14% return on long strategies and a 2.9% return on short strategies, bolstered by a healthy 20% return on Euro Equities. The macroeconomic outlook in the Eurozone improved, as Ireland weaned itself off bailouts and Spain and Italy stuck to credible austerity programs. The region finally shook off fears of a crisis.
However, the hedge fund managers believe that earnings have not kept up with investor optimism. According to Chart 1, extracted from the letter, 12 month forward earnings forecasts for the Stoxx 600 index have been depressed since mid 2011, while prices have been on upward trend. This could lead to a future correction in prices.
End to stimulus, such as taper, will contribute
The drying up of Central Banks’ stimulus will also contribute to a correction. From the letter:
“Central banks are on course to reduce stimulus, most notably the ‘Fed Taper’. This is a potentially difficult transition period as previous attempts by the Fed to stop QE had significant negative impacts on capital markets. The Fed is therefore being more cautious in its approach but there is clearly a risk that the transition period is not smooth. The Fed’s options here may become limited as the market will be concerned if an end to QE cannot be achieved without disrupting capital markets given it is now more than five years since the financial crisis and economic growth in the US has been strong for over a year.”
Over the past year, the hedge fund managers saw most stock picking opportunities in the consumer discretionary, industrials and technology sectors. In the consumer discretionary space, the fund’s investments in UK-based retailers (both on the long and short side) provided significant alpha. The sector has been in a challenging transition period over the last decade, and the companies that have survived increased competition from online retail and lower consumer spending have been more profitable, while companies that have made poorly timed expansion decisions have fallen by the wayside.
Sectoral performance
In Industrials, the long position in Thales, a French aerospace and defense company was the strongest contributor, which benefited from a management change. The Media sector, too, provided decent returns.
In the tech sector, the hedge fund also kept its significant long positions in TGS Nopec, SAP AG (NYSE:SAP), Dassault Systemes S.A. (OTCMKTS:DASTY) and Novo Nordisk A/S (NYSE:NVO), which contributed significantly to return in 2012. While these companies did not perform as well in 2013, the fund managers believe in their long-term value.
The ability to adjust to the impact of the internet has been a primary driver in the fund’s investment theses. The Media sector, in particular, was one that benefited from this thesis, with successful long positions in Rightmove, a UK-based online real estate portal and Axel Springer, a German multimedia company.
Profit margins for European firms are at historic highs but profit growth has been “nonexistent” since 2011. Equities have been trading 30% over the recent average, the same as it was in 2006. Profit margin growth is set to improve over the coming year, and the distribution of this growth will determine which sectors show potential for stock picking opportunities in the coming year.
