European vacation

Jim Campbell, who manages $3 bn-worth of assets with a team at JPMorgan, has cut his exposure to European smaller companies heavily after a strong run by the sector. He and his colleagues manage a range of assets, including the £500 mn ($814 mn) JPMorgan European Smaller Companies Investment Trust, which can borrow to invest and focuses on non-UK stocks.

The managers told shareholders on May 17 that they had reduced their borrowing from close to its maximum at the end of April to zero. Technically, gearing fell from about 117 per cent to 100 per cent. The higher the gearing, the more sensitive the trust’s share price is to moves in its holdings. The managers can range between being fully geared – 120 per cent – to holding 20 per cent cash. ‘We feel we had a very good run ,’ explains Campbell. ‘People are wary of the European smaller companies sector.’

He believes equity market investors are periodically gripped by manic emotions, which drive them to move in four cycles. The first is despair: the market moves from peak to trough as results disappoint investors’ expectations. He points to research from Goldman Sachs, which shows the worst return came at a despairing time when earnings fell by an annualized average of 7.3 per cent.

The second is a season of hope and falling volatility: investors expect a better future and enjoy their highest returns. The third cycle – growth – brings investors a time when earnings grow faster than the P/E multiple: earnings are at their highest and returns are still positive.

Campbell believes investors are currently in this growth stage. Asked about valuations, he says Europe’s small companies are at the upper end of the range, relative to larger groups. He also says, however, that in absolute terms, valuations are cheap when valued in price-to-book terms.

The fourth cycle is optimism: the P/E multiple grows faster than earnings. Returns are strongly positive and volatility increases. The next phase will be despair, which began the cycle.

Experienced hand
During the 22 years Campbell has been investing, he has seen what he calls a revolution in European investor relations. Companies used to release two earnings statements per year; now they put out results every quarter.

Investors once had no detail about operating costs, but all that has changed. German firms used to publish annual reports in English in July; now they come out in March. ‘Investor relations is now generally good,’ says Campbell. ‘The level of disclosure has gone through the roof.’

He and his team invest for the European Smaller Companies Investment Trust in companies with market capitalizations of between £33 mn and £3.1 bn. Their picks have produced a weighted average of £1.5 bn, beating the UK average of £1.2 bn. They select stocks from a possible 1,000 firms, by backing either growth companies with strong operational momentum or value businesses with a catalyst for a rerating.

The team’s biggest sectoral bet is industrial companies, which account for 33.6 per cent of the fund. This decision was driven by belief in Europe’s economic recovery – the team’s confidence in these engineering groups is a change from the recent past when the sector was one of the trust’s most extreme underweight positions.

‘I was in Germany last week,’ says Campbell, who, along with his team, visits hundreds of companies every year. ‘The key factor in Germany is that the exporters have been strong beneficiaries of the weaker currency. There is also enormous demand for their industrial goods – Germany is booming as an industrial economy.’

He and Francesco Conte, the other investment manager, argue that Germany’s industrial strength has made Europe’s economic recovery much stronger than economists expected. The European economies’ ability to manufacture the products that the fast-growing emerging economies want – expensive cars, luxury goods, consumer products and state of the art capital goods needed in manufacturing processes, planes, trains and power plants – is impressive, Campbell and Conte say in a report to shareholders.

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