What Does a Strong Euro Mean for Fund Returns?

Old Mutual Europe ex-UK Smaller Companies fund manager Ian Ormiston reflects on a strong year for European stocks and reveals where the pockets of value are

Emma Wall 3 August, 2017 | 11:52AM
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Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Ian Ormiston, Manager of the Old Mutual Europe (Ex-UK) Smaller Companies Fund.

Hello, Ian.

Ian Ormiston: Good morning.

Wall: So, UK is facing Brexit. US stocks look overvalued. Does this mean Europe is the place to be?

Ormiston: Well, there's definitely value there, but there always is for the obvious reasons in Europe, political problems, institutional problems, less profitability. European companies historically have been less profitable than certainly the US companies. But there are rays of hope, rays of light there. The politics have improved; the economics are better. This week we've seen the Q2 numbers and annualising Q2 numbers is a bit naughty, but if we did do, Europe is growing in that quarter faster than the US. and UK. It's a long time since we've been able to say that. So, yes, things are better and there is an opportunity there from the valuation.

Wall: Having said that, a lot of that positivity has been priced into the market. We did see a post-Macron win bump in European equities. So, how do you then find those pockets of value in smaller companies having reflected that positive news?

Ormiston: I think it's really interesting, because actually, the first wave of enthusiasm goes into the stuff that perform very well already, which is a natural kind of momentum, it’s a powerful tool. But for us, actually, we try to be a bit contrarian and we try and find things that are slightly out of favour. So, more recently, we've been looking in places where people have become a bit nervous again. So, auto production – not all auto suppliers are the same; they don't all have the same customers or the same end markets. Construction across Europe is another sector, which again, is very, very patchy and in smaller companies you can find one that is in a very nice niche rather than worrying about the macro across the whole other continent.

Wall: Now, the stock market has performed positively year-to-date, but also so has the currency. The euro has been strong. Now, for investors in the UK market we see currency strength as a negative thing, because of course, sterling has weakened since Brexit referendum last year and the stock market has rallied. Why therefore has that not happened in Europe? Why have both the euro and the stock market rallied together?

Ormiston: I guess the one big thing is, the external sector is benefiting from fairly benign or even positive conditions across the world. That's all fine. But for me, I would be starting to get worried about that part of Europe, the export sector. At the moment, they can manage it and the way it's moved is smooth enough that we don't need to worry too much.

But you start to see people worrying and we'll start having industrials talking as we start to approach 130 and then 140 was the level that we really, really started to worry in the past. The other part for the rally is obviously the domestic economy has started to improve, unemployment has fallen, consumption has increased which again not really a European thing and austerity has ended. So, it's a bit broader this time than historically where we've been very, very dependent on the export sector in Europe to drive any kind of growth.

Wall: And so, therefore, with those backdrops, with valuations being higher and with the euro being better, other that the sectors that you've already mentioned, are there any particular parts of the market that do look good value given that sort of quite positive backdrop?

Ormiston: I think in small caps when we think about value, we are always thinking about things that are underappreciated, so actually looking for pockets of growth as much as things that are going to recover. So, I've mentioned those two which are quite cyclical areas. But there's growth areas such as internet-enabled disruptors. They are in Europe and why do they thrive because the big companies continue to be constrained by regulation, by the economy itself, which even in its very dynamic current state is growing at 2%. So, some of the things we are looking at are genuine kind of rollout growth where the competitors are actually quite soft. They are either family-owned businesses which are financed by banks in Europe which are still not in great condition or on the other side, they are competing with big incumbent businesses which are actually great competitors to have.

Wall: And then, finally, that positive backdrop that we are seeing now, can we expect that to continue?

Ormiston: It's interesting. The economy looks like it's fairly self-sustaining. So, that domestic part, the government part, that isn't going to change in the next two years or so. The euro is a big caveat and let's see how the companies deal with it. It's interesting that a lot of the exports are in sectors where there's dominance. So, if you think about Industry 4.0, it's quite dominated by German, Swiss, Swedish companies which are very high-tech and the competition globally isn't really about price and about competition; it's about availability. So, we should be fairly hopeful that even with that slight headwind that part of the economy should be OK. The rest of it should be all right. Politics was the big fear this year, has faded. But of course, next year, when we have the German elections, which we all now assume will be fine. Next year we have the Italian election. Five Star are still in the lead in the polls. We're not talking about it; we will be talking about it early next year. So, again, it won't derail the recovery but it could just cause a few wobbles in the markets I think.

Wall: Ian, thank you very much.

Ormiston: Pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Jupiter Europe (ex UK) SmlComs I GBP Acc  

About Author

Emma Wall  is former Senior International Editor for Morningstar

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