A big concern in the region is that while companies have rerated, essentially becoming more expensive, earnings in the first three months of the year did not back up those valuations.
Speaking at Citywire Scotland, AA-rated Baker said the strong euro, which has only eased back from a three-year high in the last few weeks, is one reason for this, as it harms Europe’s competitiveness with its trading partners in emerging markets.
‘When the numbers were released, expectations were not repaid, and the key driver of that was foreign exchange expectation,’ he said. ‘The euro is up 6% on a trade-weighted basis and these companies have global exposure. If the euro had not appreciated as strongly as it had, you would see significant earnings come through.’
But the manager is heartened by the strong batch of purchasing managers index readings coming out of the eurozone of late, a leading indicator which he said had ‘almost perfect’ correlation with earnings growth. Composite PMI for the eurozone for May was 53.5, a reading indicative of growth, and he is hopeful earnings growth will start to accelerate.
The fund, which is managed by Baker alongside Jon Ingram and Blake Crawford, has returned 37.4% over the three years to the end of May, compared to a return of 27% for the Citywire European equities sector. This makes it sixth out of 102 funds.
Baker said a big reason for this outperformance was the aggressive style of the fund and its ability to take contrarian positions. His biggest bet is currently the automobile sector, an area battered by the financial crisis. Here he is backing ‘key player’ BMW, which is the fund’s fifth biggest holding, and tyre manufacturer Continental.
‘These guys are benefiting from a decent improvement in car demand in Western Europe, as consumer confidence increases,’ he said, pointing out the average length of car ownership in Europe is currently at a high of 8.5 years. Also, sales are up 6% this year as consumers feel more secure about the economy and want to upgrade to more fuel-efficient vehicles.
BMW has also benefited from its strong performance in the Chinese market as the appetite for luxury goods continues, and Baker noted the car manufacturer’s joint venture in China, BMW Brilliance, had seen sales grow by 25% in the first four months of the year.
‘The growth prospects for European companies are influenced by emerging market growth and global growth generally, and going in to this year there has been a higher level of optimism than before,’ he said.
Another advantage of the fund’s unconstrained style is that can avoid the companies he doesn’t like.
He has steered clear of some of the troubled eurozone banks, such as Credit Suisse and UBS, whose earnings have been held back by a decline in trading activity, and also BNP Paribas. This is facing concerns it could be hit by a $10 billion fine and be banned from operating in the US after potentially defying trading sanctions.