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Fund in Focus: European Special Situations


Fund in Focus: European Special Situations - February 2024


[00:00:00] Nick Peters: Hi, this is Nick Peters,investment advisor at Marlborough Group, and today I'm joined by David Walton,the lead manager on Marlborough's European Special Situations Fund.

[00:00:17] Nick Peters: Hi, David.

[00:00:18] David Walton: Hello, Nick. Good to be here.

[00:00:20] Nick Peters: Okay, we'll start with first question. Do you just want to take us through your investment highlights and perhaps the low lights from last year, 2023?

[00:00:29] David Walton: Thank you, Nick, certainly. So overall, the fund net return last year was 6.6% and the gainers we had included two companies which were acquired, two smaller companies and three other companies which reported strong profit growth and achieved a re-rating thanks to that.

[00:00:50] David Walton: Overall, the fund performance was held back by its high weighting in smaller companies which didn't do aswell as large companies which we're going to discuss later.

[00:00:59] David Walton: But yeah, in summary, the fund had a positive return with some winners and at the same time, the highweighting of small companies was a drag on performance.

[00:01:09] Nick Peters: It was interesting to see how smaller companies performed better in the final quarter, and there's been a lot talked about valuations, differentials between the two.

[00:01:19] Nick Peters: Do you think there's still a gap between large and smaller companies in terms of valuation?

[00:01:24] David Walton: Yes, I think there is. Based on the JP Morgan research, which we read from time to time, there's a discount of 10% currently between small and mid caps compared to large caps. So small midcaps, forward PE is 14.4x, whereas large caps, forward PE 16.2x.

[00:01:45] David Walton: And then looking at the the Marlborough European Personal Situations Fund, the forward PEs for that fund,if you aggregate all the companies held, is only 11.6x, which illustrates that the smaller you go in terms of market cap terms within the small cap universe,generally the lower the valuation.

[00:02:05] David Walton: So certainly there is a very big difference between companies at the small end of the small cap universe and large caps now.

[00:02:14] Nick Peters: And you mentioned that a coupleof your holdings were bid for last year and this feels like there's a lot of M&A activity in your world. Who's buying?

[00:02:25] David Walton: Well I think in that case last year the fund received five takeover offers for different holdings and then of those five, three came from industrial buyers, one came from a private offer by the management in combination with a venture capital fund.

[00:02:42] David Walton: And the fifth one received an offer from a large Canadian pension fund, which was then advised by a specialist property manager. That was the Norwegian company Self Storage Group.So, more industrial buyers overall than venture capital buyers.

[00:03:00] Nick Peters: And there's no reason to think why that trend shouldn't continue?

[00:03:03] David Walton: I think certainly the discounts which small companies are trading at currently is proving attractive to industrial buyers. For them it's a good opportunity to make an acquisition quite cheaply. Also, large companies themselves are able to borrow money still fairly cheaply even with the most recent increases in interest rates.

[00:03:23] David Walton: So for them, if they can borrow money even at 5% or 6%, it still makes sense to buy a company on a PE of 10 or 11x.

[00:03:31] Nick Peters: Okay. And if we turn to the fundnow, can you give us a flavor of what's going on in the fund?

[00:03:37] David Walton: Yeah, so essentially we have a fairly long term approach, so the turnover of holdings in the fund is relatively low.

[00:03:45] David Walton: We have a holding period of,well, on average between five and seven years. So we're not actually trading these companies frequently. So the fund's portfolio breakdown is very similar now to what it was a year ago. As I said, we have a high weighting and small companies. Currently, the largest holding of the fund is a French company,which is a market leader in market research called Ipsos.

[00:04:09] David Walton: That's trading well, recently put out a positive comms about the Q4 trading and the chairman is buying shares in that company. That's on a Forward PE of 11x. So, yeah, that's an example really of why we actually continue to hold the fund holdings, because they are generally growing their earnings and also quite cheap.

[00:04:30] David Walton: So we're not really making a lot of moves in terms of selling holdings and buying new ones because the ones we own we are happy with those ones and we see quite good upside in them.

[00:04:41] Nick Peters: So you mentioned the low turnover. There is a view that given how strong the market's finished last year that actually this year it's going to be more difficult for them to make toomuch headway and the theory goes that in order to make money you should perhaps have a more trading orientated and 'top and tail'.

[00:04:58] Nick Peters: What are your thoughts on that sort of approach?

[00:05:00] David Walton: That could all be right, I think Nick because certainly the economic growth stats we're seeing are fairly lackluster so far this year as well.

[00:05:10] David Walton: However, our approach is to buy into well managed growth companies cheap valuations And then hold those companies for a number of years as they can progress their business, grow their sales and profits over time, and then hopefully achieve a upward re-rating on the stock market.

[00:05:29] David Walton: And we aren't actually very good at predicting the macroeconomic statistics that are going to come out, whether we're going to have higher or lower growth, whether we'll have higher or lower interest rates. We're not really that good at predicting that, so we just try to focus on the company fundamentals and be patient, and wait for those companies to deliver profit growth.

[00:05:48] David Walton: Which, sometimes it can take longer than we expect to arrive, other times it can come sooner, or there can be a takeover. So, we're not in control of when these different events happen,but the key thing for us really is to stick to our investment process, make sure that we're owning well managed growth companies for the fund, where the valuation is attractive.

[00:06:09] David Walton: Hence, talking about it, Ipsos,the largest holding. Similarly, we own a company in Greece called Sarantis,which is doing pretty well. That's a mini Unilever over there. The market is less competitive in Greece and the Balkans because the likes of Unilever and Procter & Gamble, they're not focused on those fairly small markets in a globalcontext.

[00:06:32] David Walton: So really, it's just about trying to keep the fund invested in companies where they have a decent market position. They're not facing really sort of cutthroat competition from very large companies or selling products which are commodities.

[00:06:46] David Walton: Equally I think this morning we had news from one of our other holdings in Italy, B&C Speakers, which is the world leader in loudspeakers for concerts.

[00:06:55] David Walton: So all of the big touring groups will be using B&C speaker components in their speakers for their concerts. So their sales have grown well last year and there's a further growth expected for 2024. Shares are bumped up today 4% and the PE is still 13x, so that's really what we're doing there, just focusing on company fundamentals.

[00:07:16] Nick Peters: If we look ahead for this year whilst understanding that fundamentals and bottom up stock picking is key to your approach. There are several general elections in Europe this year.

[00:07:29] Nick Peters: How, perhaps in theory, do you think that could impact markets and sentiment?

[00:07:35] David Walton: Yeah, I thought this was a very interesting question, Nick, in terms of elections. But the reason it's a bit ironic really, is because the most important election for Europe this year isn't taking place in Europe. It's taking place in the USA. So that is absolutely key.

[00:07:48] David Walton: And the other elections in Europe, without any disrespect to the countries involved here, we're talking about Finland, Belgium, Austria, Romania, and, okay, the UK.

[00:07:58] David Walton: But they, I don't think will beas important for European equities compared to the result of the US election. So yeah, I think that's the key one really and because the US economy has remained pretty strong despite some forecasters being concerned about a downturn that hasn't really come through, but obviously it's always finally balanced between government spending in the US and the Fed's behavior as well.

[00:08:22] David Walton: So I think that's really the important election for this year.

[00:08:26] Nick Peters: And how do you think about that election in terms of positioning for the fund? Is there anything you can do ahead of the election or is it more reacting to news flow thereafter?

[00:08:36] David Walton: I think it's more just about making sure that we're not exposed to companies that are on a high rating andc urrently perhaps profiting from a very strong US economy, which, okay, it might continue to be strong in [20]25 or it might not.

[00:08:53] David Walton: So it's more about making sure that we're not exposed to a company with a high valuation where perhapsinvestors are effectively betting the house that their strong US profits will just continue onwards.

[00:09:05] David Walton: So we don't hold any companies which are exposed to the current boom in US construction. But, you know,equally, we don't hold any companies which are exposed to the US Inflation Reduction Act, which is giving very large subsidies to particularly renewable energy linked companies.

[00:09:25] David Walton: So these are the cases where if there is a change in the White House late this year, then you could see some sharp changes in business environments there.

[00:09:35] Nick Peters: Thank you, and so politics aside,what other sort of thematic drivers do you think we may see in in Europe?

[00:09:42] Nick Peters: There are discussions about margins and perhaps the impact of interest rates on margins. What are you seeing there?

[00:09:49] David Walton: I think that we're seeing aslowing of inflation in Europe this year, but it's not coming down rapidly but it has come down compared with a year ago. At the same time, I think the inflation which affects companies costs is a bit stickier.

[00:10:04] David Walton: So this is like wage inflation, another can be inflation in property rental costs, for example, which can be indexed to a backward looking inflation measure. So that means that companies will face inflation in their own costs in this year, even if inflation at aheadline level is coming down. So that will still create some pressure on company margins in 2024.

[00:10:29] David Walton: Against that, what you might see is a slight improvement in economic growth in Europe and perhaps in China, I don't know Asia as well, after a sluggish couple of years. So that's a potential there for a positive surprise.

[00:10:44] David Walton: I'm not going to hang my hat that that will happen, but there is at least scope for that after a fairly slow couple of years, both in Europe and Asia, particularly China, in terms of economic growth.

[00:10:54] David Walton: And that will be helpful because you then get operating leverage for companies coming through with a highersales base, even if the gross margins don't go up, you're getting a higher level of sales over a fixed overhead. So that could be positive.

[00:11:09] Nick Peters: Thank you, David. It feels like another intriguing year as always.

[00:11:13] Nick Peters: David, thank you very much for joining us.

[00:11:15] David Walton: Super. Thanks, Nick. All the best.

[00:11:18] Nick Peters: That was David Walton, lead manager of Marlborough's European Special Situations Fund.

[00:11:23] Nick Peters: And if you'd like to find out more about the fund, please go to our website Thank you.