On prowl for star mid-caps
Edinburgh fund house Martin Currie believes European stocks are in for bumper profits due to a virtuous combination of rising sales and the benefits of cost cutting. In particular they are promoting the attractions of mid cap stocks, which tend to outperform as an asset class as markets recover.
In fact, they offer the only focused portfolio investing exclusively in pan-European mid caps. The new Martin Currie Pan European Mid Cap Equity Fund is utilising the group’s long experience of adding value through mid cap investments in other funds. June 2002 was when this performance was “broken out” in a separate fund, run by Eric Woehrling and team of European stock picking specialists. Woehrling says: “With 60 years experience on the European team, 72 years on the sector specialist team, and an investment process with a 17-year track record, we think it’s a young product with plenty of longevity behind it.”
The portfolio is fairly concentrated, containing between 25 and 30 stocks. Woehrling says it is hard to find stocks which meet the team’s quantitative criteria (quality, value, growth and change) as well as passing their qualitative tests (does the business plan which drives the numbers behind the quantitative screen stack up, is the stock over-owned etc). “Having a short list makes it easier not to compromise. It also means you can wait for something to be really cheap before you buy it (for example, Easyjet), rather than buying it when it’s a little cheap just because you need another name. This fund is about finding hidden gems. Once you’ve found such a gem it’s a shame to put less than 3% of your fund in it. With a focused fund you have no fillers and get more bang for your buck.”
The team are pure stock pickers, and as such they don’t pay attention to sectors or countries. Woehrling says: “We look at the drivers of a stock to make sure we are not overly exposed to any particular theme, but these themes can cut across sectors and countries (eg, interest rates or globalisation). We also tend to avoid taking strong bets on market direction. So when we were outperforming a falling market we still had tech, temporary employment, and industrial stocks in the portfolio. While we were outperforming a rising market we stuck with positions in toll roads and tobacco. This may also explain some of our low volatility.
The team relies on traditional methods to control volatility: “We can’t prove statistically that this sort of portfolio is going to have a low volatility in future. All we can do, in a very old fashioned way, is use our common sense. We analyse the business models in detail, and we make sure that there are not too many stocks in the portfolio which are being driven by the same factors. What we observe is that a lot of the factors which drive our stocks are stock-specific rather than top down, and that they are therefore not highly correlated. But we can never point to a statistical exercise which gives us certainty that our volatility will be low. All we can do, I’m afraid, is assess each investment on its merits and take responsibility for it.”
Biases may exist in the portfolio, but they are entirely due to stock picking and are not frowned upon: “What we found at the tail end of 2002 and the beginning of 2003 was that more and more cyclical stocks were cheap and demonstrating stable or rising EPS estimates. This led to a certain cyclical bias in our fund toward the end of March 2003, which still pertains today. A lot of these cyclical stocks have done well, but as long as they fit our process (cheaper than the market, growing faster than the market, well financed, experiencing positive change) we will hold on to them. The last four stocks we bought were Storebrand, Swiss Life (both insurance), Prosieben (media) and Tele2 (telecoms). I suppose you could say the first two are geared to rising bond yields and the next two are “growth” stocks, but I don’t think it’s enough to constitute a trend. We’ve also been increasing our weighting in Altadis (tobacco).” The manager believes his team has the breadth of experience to make the most of whatever opportunity arises in Euro mid caps. So far, they have made over 50% in training shoes (Puma), tyres (Continental), banking (Anglo Irish) and shipping (AP Moeller).
Overall, the team at Martin Currie is unconcerned about whether the mid cap asset class outperforms. They only need 25 or 30 of them to do so. Woehrling comments: “Over the short and long term, simply buying mid caps on its own does not improve your performance. It’s only buying the right mid caps that does. Structurally, mid caps will outperform if they are under-researched, under-owned and undervalued, and if some positive change reverses that undervaluation.
“As long as the market remains inefficient, mid caps will offer focused stock pickers the opportunity to outperform. Luckily for us, we think the market is still pretty far from efficiency.”