BY BERTRAND FAURE
February marked the return of volatility to European financial markets. Volatility picked up on Friday, 2nd February with the rise in average hourly earnings growth in the US from 2.5% year-on-year in December to 2.9% in January. This, combined with a recovery in price inflation, lead investors to reassess the Fed’s policy outlook significantly.
According to the Investment Adviser, last month’s equity market correction shows that the expectation of tighter policies is now starting to weigh on broader financial conditions.
Given the absence of significant market volatility for an extended period, this type of correction was likely to happen, as detailed by the team in the December 2017 commentary. As a result of the Investment Adviser’s macro view regarding increased risk, the Fund’s cash level was increased from 9.25% at the end of December 2017 to 15.1% at the end of January 2018, increasing further in the early days of February towards 18%.
In that context, the Fund managed to outperform its benchmark by 0.53 percentage points on a relative basis – returning -3.28% in February. Year to date the Fund’s performance stands at -0.91%, translating into a 1.30% outperformance versus its benchmark.
In the light of the above, four positions were sold during the month: Aalberts, Daetwyler, Komax and Moncler, with all of them having produced very satisfactory returns for the Fund: +26.3% for Aalberts, +27.0% for Daetwyler, +38.2% for Komax and +69.8% for Moncler respectively. This said, the position’s risk reward trade-off was no longer high enough to maintain an investment in these companies, especially at a time when market volatility provides the Fund with much better entry points into other positions.
Granges was the largest contributor during February, followed by U-Blox and Va-Q-Tec. Mauna Kea, Tom Tailor and OVS were the three largest detractors. The investment thesis for the current portfolio positions remains unchanged, and the results that have been published so far exceeded expectations for 2017 and were accompanied by positive expectations for 2018. Maintaining higher than usual cash levels allows the team to take advantage of the volatility, by buying into new positions and increasing the weighting of some existing positions at improved levels, thereby increasing the opportunity for outsized returns in the future. The price discipline, that is an integral part of the Fund’s investment process, helps to protect the Fund in these situations and tends to produce even higher returns for investors in the longer run, compared with a market without volatility.
According to the Investment Adviser, European markets have better valuation fundamentals than the US markets (PE 18 of 14.2x for EuroStoxx 600 vs. 16.6x for S&P 500, dividend yield of 3.5% vs. 2.0%). As a consequence and in the Investment Advisers opinion, the team anticipates that European markets should be less impacted by the coming rise in interest rates, no matter if there will be 3 or 4 rate hikes in the US this year.
Similar to other comparable market corrections experienced recently, such as the one after the Brexit vote in 2016, new opportunities will inevitably arise in the Investment Adviser’s universe. Consistent with the team’s philosophy, the focus will be on identifying companies that create sustainable value for their shareholders. The Investment Adviser believes that Free Cash Flow generation is by far the best protection against negative market movements. According to the team, companies that can generate between 8% and 10% free cash flow will remain better investment propositions than a 3% treasury bill, although the market sometimes needs time to recognise this.
The views and statements contained herein are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the Fund as of 15/03/18 and are based on internal research and modelling.