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Barings' European team sounds profit warning alert

Barings' European team sounds profit warning alert

Last year was a strong one for European equities, with small caps the standout performers.

In the 12 months to the end of November, the average European equity fund returned 25% compared with 22% from its rivals in the global equities sector.

Small caps did even better, with the typical European small and mid cap fund up 34%, against 31% for their global counterparts.

In tandem, investors rediscovered their enthusiasm for Europe. In the year to November 2013 (the latest month for which statistics are available), a net £10.3 billion flowed into European equity funds, according to the Investment Management Association (IMA).

This contrasts with the £2.8 billion they attracted through the prior year. IMA European funds now contain £45 billion, a tenth of all the money held in open-ended equity products.

So 2013 should, then, have been a vintage year for the small cap-focused Baring Europe Select Trust.

In one sense, it was. Managed by Citywire A-rated Nicholas Williams and Colin Riddles, it swelled in size through the year from around £400 million to just shy of £1 billion.

‘Last year there was a very obvious shift in sentiment towards people liking Europe,’ Riddles said.

Performance, however, lagged the benchmark, although it has beaten its peer group. In the year to the end of November, Baring Europe Select produced 32.6% while the Euromoney Smaller European Companies ex UK index surged by 41.6%.

‘Last year was quite painful as people were buying anything,’ Riddles admitted.

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.

‘We have 7,000 companies to choose from, so we don’t need to take stupid individual risks.’

So what has made the cut? From that universe of 7,000, Riddles and Williams have whittled down a portfolio of around 100.

One of their highest conviction calls at the moment is Intrum Justitia, a Swedish debt collector. In 2009 the company appointed Lars Wollung as chief, who set about focusing the then broad provider of financial services on a core competency. ‘He realised it was a very good company at collecting debts from other people,’ Riddles said.

Wollung developed the internal division and transformed Intrum Justitia into a pan-European group that acts on behalf of giants such as Nordea and Vodafone. Intrum Justitia is buying distressed debt for 10 cents in the euro, and posting a return on equity of around 20%.

Over the past year its share price has soared by 81%. ‘The environment was right. There was lots of business to pick up and it was in the right place to do so,’ said Riddles.

Among UK small caps, one of the pair’s top picks at the moment is packager DS Smith. It bought a Swedish rival in 2012, and is now reaping the benefits of cost synergies.

Its share price is up 62% over the past year, and Riddles is now looking for organic growth. ‘What we are hoping for now is a little bit of economic help,’ he said. DS Smith’s emphasis on the domestic consumer makes well positioned for the UK’s nascent recovery.

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Nicholas Williams
Nicholas Williams
46/69 in Equity - European Small & Medium Companies (Performance over 3 years) Average Total Return: 44.91%
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