IM Argonaut European Alpha manager Barry Norris has seen his pronounced underweight in European banks cause short-term underperformance over the past six months, but he is sticking with his belief that the sector is too volatile to back.
Banks are 'zombie equity'
The fund also has no exposure to peripheral Europe and this region, along with many financials, has been among the best performers following liquidity injections and positive noises from the European Central Bank in recent weeks.
But Norris remains happy to avoid banks, which he describes as ‘zombie equity’, and is maintaining his large overweight to the region’s strongest economies and also to a handful of quality growth stocks in core Europe from the insurance, autos and retail sectors.
He tells Citywire Selection: ‘We have had a disappointing six months on a relative basis but we still view banks and southern European equity as zombie equity. It is very hard to make a case for banks as we believe they have not made enough provisions for bad debt and unless there is higher growth, their provisions will have to remain high.
‘But we call them zombies because they are not totally dead and every couple of months they come back to bite you in the backside.’
Norris has held no banks for about four years and now thinks they are not even trading on cheap valuations.
‘It is very important to stick with our process. We look for stocks with superior earnings momentum and we are happy to pay up for these higher quality companies.’
Recent examples include German auto group Volkswagen and reinsurer Hanover Re, and French high-end commercial property firm Unibail.
Norris started adding Volkswagen three months ago and it is now 4% of the fund, initially attracted by the higher margins being gleaned from the Porsche and Audi brands it now owns.
‘In a low-growth environment, ironically it is growth stocks that do better. Porsche makes 20% margins and Audi 12%. These are great brands recognised all over the world and Volkswagen has transformed itself into a higher margin business.’
Norris says the Volkswagen brand itself is now taking a bigger share of the mass market as it has been able to borrow at more competitive rates than French rivals such as Citroën and Peugeot.
While Norris holds no banks, Hanover Re and Norwegian reinsurer Gjensidige make up 4% of the fund each.
‘While we think banks have underprovided for bad assets, insurers have built up huge capital reserves on their balance sheets, which gives them a better buffer against earnings downgrades.
‘Hanover’s auditors now think its provisions are probably too high so it is understating its profits and we expect to see serious earnings growth and big dividends. This is an industry with great pricing power.
‘Gjensidige has a huge market share of Norway’s insurance market and it is also overprovided for with hugely profitable contacts.’
French property company Unibail is also a key holding, doubled to 4% of the fund over the past six months. The majority of its high-end shopping centres are focused in Norris’s preferred core Europe, with most of its operations in Germany, Scandinavia and the Netherlands.
‘Prime property is a great asset to own in a low-growth environment and Unibail has managed to keep increasing its rents, so it has great cashflow and a yield of 5%. Overall, property is a good hedge against the central banks’ [financial] engineering when you consider that 10-year government bonds are at 1.8%. We view it like gold but with a yield.’
Nestlé remains Norris’s biggest holding and while its share price performance has been flat recently, it is still providing his fund with a 3.8% yield.
Sticking with Nestlé
‘Nestlé is a great example of a quality stock [where the share price] has gone nowhere recently because people have been selling it down to buy Spanish banks.
‘We have invested almost exclusively in Germany, Switzerland and Scandinavia, and have been able to access high-quality companies at a discount because they have the European tag attached to them.
‘European equities look very cheap compared to other markets and it is frustrating that many are investing in banks when you can get stocks in attractive parts of Europe with global exposure but trading on a discount.’
Over five years to the end of October, Norris has returned 3.5% compared with -7.6% by the FTSE World Europe ex UK benchmark.