Pieter Taselaar and Thijs Hovers have carved out a reputation as one of the top-performing equity hedge fund management teams focused on European markets. With net-of-fee returns dramatically exceeding the MSCI Euro index on a 1,3 and 5-year basis, their Lucerne Capital Fund has delivered average returns in excess of 13% to investors since inception in 2002.
The successful partnership between Taselaar and Hovers began at ABN AMRO in the Netherlands where they held senior trading and research positions, respectively. With a process for identifying opportunities in European stocks that extends to the global markets they compete in, the two are as comfortable discussing emerging trends in developing markets as they are the minutia of a specific company’s balance sheet.
With year-to-date performance that has outstripped all major European indices, the pair sees even more potential for stocks there in the coming quarters. The two think Europe will experience a sharp burst of growth as economies turn a corner, and outlined the sectors and types of companies that stand to gain the most when this occurs.
Excerpts from an interview with Pieter and Thijs are provided below. You can find the unabridged version at Business in Canada.
BiC: What do you see, right now, as the big picture opportunities and big risks in European equities?
Pieter: Our thesis is that there are a lot of opportunities in Europe in cyclical areas, purely because we’re coming from very, very depressed levels. If we look at automotive sales in most of the big European countries, we’re back down to the levels that we saw in the early 1970’s, and so we think there’s a big catch-up of demand in terms of consumer goods, durable consumer goods, and capital goods that is going to take place. Our thesis is NOT that Europe is suddenly going to be consistently a faster grower than the rest of the world, but we do clearly see this catch-up ahead of us.
BiC: So you see this recovery continuing even if growth levels remain modest.
Thijs Hovers: I think what you’re going to see is a reluctant recovery: a lot of companies and consumers are going to be forced to spend. We’ve now seen 8 or 9 consecutive quarters where the cap/ex cycle was negative, and that is one of the longest downturns in capital expenditures since the Second World War. At some point, companies will have to reinvest in their businesses.
And then you come in a territory that’s very interesting to us, because what we now look at is which companies over the last five years have been able to successfully reduce costs and retain profitability despite the drop-off in demand, but have enough capacity left that they can benefit from a pick-up in demand by generating high profit margins.
You probably need a much lower top-line level, or much lower overall GDP output, to get to big earnings again. That’s the phase we’re in now. In different geographical areas and end-markets, we’re going to see a recovery. Probably, it’s not going to go from these low levels to 2 per cent growth slope, for the next five years. You’ll need to have some kind of very sharp bounce first, and then growth will be somewhat modest.
BiC: When you look at a company, there’s something that obviously goes beyond the valuation and the opportunities from a business standpoint. In the past, the two of you have focused on a lot of mid-cap companies and companies that are heavily focused on individual industries. Is there a commonality that you look for in management? Are there traits that you see as particularly positive or as warning flags?
Thijs: At this phase, you don’t want to be caught in what we call the real ‘dogs’, the companies that might look cyclical and potentially benefit but could still be wiped out by a huge rescue rights issue or something like that. Together, we have a very long period of experience in looking at these companies and have known them for a very long time already, and we can set up meetings with management teams very quickly — and we have more than one meeting.
If you see that the management is more focused on letting its share price go up over the next six months instead of saying, ‘Well, we’re trying to gain market share and increase returns on capital,” — that’s a big red flag. Another thing could be if the CEO you meet now and the CEO you meet three months later tell completely different stories. So that’s how we try to discern between higher and lower quality companies. Later on, we start phasing in what trends we’re seeing and which companies could potentially benefit from them. But that’s separate from analysing the quality of a business.
Pieter: The quality of the people running the businesses is key. It’s almost like investors trying to pick a portfolio manager, but we’re trying to pick the right business managers. That means they’re setting achievable goals that, from our perspective, are going to benefit the shareholders over the long-term, that they actually work in a consistent way to achieve those goals, and that the execution and message is consistent over time, as Thijs said.
BiC: We talked a little bit about the trends and situations that companies are finding themselves in. What about the macro perspective?
Pieter: If you look at equity yields and equity risk premiums in Europe, it’s pretty attractive relative to the other two developed markets, which we think are Japan and the U.S. And developed markets are, at this stage, are somewhat more attractive than emerging markets. So if you look at all opportunities, we think that domestic Europe is the place to be, relatively speaking, given valuations.
BiC: When you’re dealing with these mid-cap names, are they finding it difficult to access credit markets or is that more a phenomenon of the southern economies. Is credit still flowing in the core economies?
Pieter: That’s a good point. Thijs had a talk with a Northern European company today, and there is a big divide between Northern Europe and Southern Europe. Basically, the southern European banks are being funded primarily by the ECB with very cheap money, so they’re on life support. The ECB will continue to fund them, because the consequences of not doing so would be too dramatic, but it really benefits funding and lending in the stronger countries.
We were talking to a company that’s looking to do acquisitions, and we asked them “Do you have to go to the bond market to get financing?” and the CFO basically said no, we can go to the banks. And the banks are lining up to lend to companies with strong credit. That phenomenon you see is the easy monetary policy that is there to keep the periphery going is basically benefiting lending in Northern Europe. That’s a very big trend.
THIS ARTICLE WAS ORIGINALLY PUBLISHED AT BUSINESS IN CANADA.
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