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View the article online at http://citywire.co.uk/wealth-manager/article/a728305

Barings' European team sounds profit warning alert

by Robert St George on Jan 22, 2014 at 13:21

However, the fund’s longer-term record remains impressive, showing an annualised return of 14% over the past three years compared with the index’s 10.9%.

But if 2013 saw a rising tide lift all boats, Riddles thinks 2014 will have a very different hue.

‘Last year was very broad brush. You just wanted to be in European small caps,’ he explained. ‘This year will see more profit warnings.’

A particular area of concern for him is Spain, where he was astounded that last year some companies’ earnings halved while their share price doubled.

The indicative country exposure for Baring's recently launched European Opportunities fund has Spain at a 2.3% underweight relative to its benchmark MSCI Europe Small Cap index.

Riddles nonetheless pragmatically holds the Spanish stock exchange in his portfolio, which he remarks has benefited from the bounce in local stocks.

The process Williams and Riddles employ identifies firms that can upgrade their earnings estimates, whether via self-help, acquisitions or an improving economic outlook. Of those that make the portfolio, the duo expects a 40% upside to the share price.

The difficulty in the current environment is that earnings estimates are quite elevated. Riddles reports a market consensus expectation of 10% profit growth for UK small caps this year and 20% for their cousins across the Channel. 

‘Companies need to deliver now. The companies have to justify their share prices,’ he said.

He doubts every firm buoyed by the European rally will be able to achieve this, which gives him confidence his funds’ relative performance will turn around in the months ahead.

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