The Fund aims to achieve long-term capital appreciation by investing in the equity securities of companies listed primarily on exchanges in Europe, including the UK.

The anticipation of interest rate cuts by the European Central Bank (meanwhile, at the time of writing, a fact) propelled European equities up by 2.45% (in euro terms) in May and helped small and midcaps to recover much of their year-to-date relative losses. 

This was a tailwind for the fund, which performed strongly for a second month and returned 6.46% (in euro terms) in May. Interestingly, only four stocks explain the fund’s 4% relative performance: French caterer Elior (shares rallied 42%), electrical retailer Ceconomy (up 44%), surface solution and polymer processor Oerlikon (up 25%), and minerals group Imerys (up 23%).

Each reported earnings and forward guidance ‘somewhat’ above expectations, but price reactions were fast and aggressive. This was not a surprise to us, with valuations rock bottom: the intrinsic value of each of these four stocks is still more than double current, increased prices. Therefore, despite these investments now having a much larger weight in the Fund, we did not reduce any of the investments with, finally, momentum turning. 

The weighted upside of our investments in the fund remains above +140%. This upside percentage might seem aggressive but reflects the Fund’s contrarian and patient value strategy to exploit the polarisation of valuations in the broader market. In the world of passive investing, where index and thematic ETFs are gaining popularity, ever-accumulating flows reinforce price momentum, with prices running further ahead of economic reality and valuations implicitly discounting an ever-further-away future as a fact. In crowded ETF stocks, both stock-specific and macro-related risks are building.

But outside the undifferentiated world of passive investing, lack of (or often negative) money flows had the reverse effects on prices, valuations and risk. For example, as European Small Cap (MSCI) accumulated a -30% underperformance in the last 3 years, small and midcap prices discount less and less a positive future and in selective cases run behind positive economic realities. Too low valuations and earnings stability or improvements are the sweet spot for patient value investors.

The pool of European opportunities remains large and deep for fundamental, bottom-up stock pickers. At the end of last month, we invested in the family-controlled Italian food group Newlat Food (Mkt Cap €350m). Newlat Food produces branded agri-food products (milk, dairy, pasta, etc.) and generates €800 m in sales, mainly to retailers across Italy, Germany, and the UK. The announcement of a £700m leveraged acquisition of Princes Ltd (€2bn of sales) will transform the scale and structural profitability of the group with complementary products/brands and existing spare production footprint, providing very quantifiable cost synergies that will lift Equity Free Cash Flow quickly to above €100mn. At our purchase price, Newlat Food trades on only 3.5x Equity Free Cash Flow. We estimate the absolute fair value to be well above €1.1bn (i.e. triple current market cap), and this reasonable valuation is supported by looking at the relative valuation of industry peers like UK-listed Premier Foods or Spanish Ebro Foods.

After careful consideration and in light of recent strong performance, we made a strategic decision to sell our long-term holding in SBM Offshore. SBM is in the process of transforming away from a low-beta capital intensive FPSO (floating oil production storage and offloading) ‘build, lease and operate’ model, to its original 1990s model of turnkey ‘build and deliver’. The market (especially quant funds and the like) might like the optical effect of low capital intensity and higher returns. We remember well the unquantifiable impact of a rising beta. 

JOHCM/MSCI Barra/FTSE Group/Bloomberg/Lipper.

Data shown net of fees, net income reinvested.Please note that fund performance is shown against the MSCI Europe NR 12pm adjusted in GBP. Performance of other share classes may vary and is available on request. Data for the period 7 May 2003 to 31 December 2012 is shown against the FTSE Eurofirst 300 TR Index. Where shown, monthly returns table shows compounded discrete monthly performance.

Past performance is no guarantee of future performance. The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested. The Funds investment include shares in small-cap companies and these tend to be traded less frequently and in lower volumes than larger companies making them potentially less liquid and more volatile.