Fund managers series

On the hunt for value in European stocks

Matt Williams, BlackRock's director of European equities and product strategist for its European Equity Income Fund, discusses the outlook for these stocks in the latest in our series on fund managers and market experts.

Mr Matt Williams joined BlackRock in 2012 after having worked as an equity research analyst at a global investment bank and at Capital Group in London, covering European industrials.

BlackRock's European Equity Income Fund invests at least 70 per cent of its total assets in the equity securities of companies that are domiciled in Europe, or that exercise the predominant part of their economic activity there. As of June 30, the fund's annualised one-year total return was 11.53 per cent, while its three-year total return was 5.98 per cent. Its annualised total return since the launch has come to 10.22 per cent.

Q What are your key considerations when evaluating a stock?

A Our evaluation process starts with dividend reliability. This includes a detailed analysis of the companies' balance sheets and their debt structures, which can include bond covenants. Because equity dividends get paid last, behind bond coupons, we look at all possible threats.

As a result, we tend to identify companies with highly competitive positions, which in turn drive earnings stability and solid profitability. We then look for cash-flow characteristics. Dividends need to be paid in cash (not scrip) - this requires companies not only to be good at generating cash, but also to display strong corporate governance in ensuring that cash is returned to fund-holders.

Our fund has a specific risk constraint limiting overall volatility, so we tend to avoid volatile companies such as some in the mining sector or airlines. We also assess valuation, which can be an issue even if dividend reliability isn't. Some high-quality companies have inflated valuations and it is critical to avoid such firms.

Not all European equities are cheap, says Mr Matt Williams, but the potential for earnings growth is strong amid dissipating political risk.
Not all European equities are cheap, says Mr Matt Williams, but the potential for earnings growth is strong amid dissipating political risk. ST PHOTO: LAU FOOK KONG

Q What is the current climate and outlook for Europe?

A The presidential election in France was seen as a significant potential hurdle at the start of this year, but Mr Emmanuel Macron's victory was taken positively, and we have seen heightened interest in the region. We are cautious as to how many of his reforms can actually be implemented, but it is a positive step.

Global macroeconomic data continues to be broadly positive - from which European companies are well placed to benefit, especially given the competitive currency. Many European companies are actually global firms that earn money worldwide even though their headquarters are in Europe. We have seen some quarters of strong earnings growth, and a positive outlook for the future.

Q Are the valuations of European equities attractive compared with those of US or Asia-Pacific equities?

A European equities now benefit from dissipating political risk, an ongoing macroeconomic recovery, potential for earnings growth and relatively attractive valuations. They offer favourable yield premiums as compared with equities in other regions and anything offered by government or corporate bonds. Furthermore, unlike bonds, equity dividends can grow.

That is not to say that all European equities are cheap. Certain sectors have performed very strongly, and we would be cautious about investing in them (for example, banking). Fortunately, our actively managed fund allows us to be benchmark-aware but not constrained, and we can thus avoid overvalued stocks.

Q What are the best- and worst-case political scenarios for the euro zone? How should investors manage risks?

A European political risk has dissipated, with three positive election results so far this year (one election in Holland and two in France). We await Germany's election next month (where both major parties are pro-European), and we continue to monitor Italy, where we expect an election before March next year. We also know that Greece's debts need to be rolled over at various points.

Some investors are cautious given Britain's hung Parliament. Clearly, the market wasn't seeking a minority government but, on the plus side, a softer Brexit seems more likely. We would, however, highlight the difference between British-listed and British-exposed companies.

Investors should recognise that political events often represent good investment opportunities, as evidenced by Brexit. Political risk has a relatively limited impact on company earnings, but investors are sometimes spooked by short-term volatility spikes - at such times, to quote Mr Warren Buffett, they might do better being "greedy when others are fearful".

Q Despite the political uncertainty, is now an opportune time to invest in certain countries or sectors? Which are the most appealing?

A We invest in companies, not countries. Some clients have asked about our British holdings, given recent political events. The British-listed companies we hold are global firms that earn money worldwide, and we are comfortable with their dividend reliability and valuations.

However, this differs from our view on the British consumer sector, where we are more cautious. We currently have little exposure to this sector, which is seeing imported inflation and rising personal indebtedness.

We are significantly invested in insurance, where we see specific companies with above-average dividend yields underpinned by strong free cash flow yields. This allows for premium yields and good reliability.

Q What are the key drivers for European equities this year?

A Broadly speaking, key drivers are how much companies can grow their earnings, what the market is willing to pay for these firms, and how many are willing to pay.

Strong earnings growth has addressed the first point this year, and we are confident that this could continue.

On the second point - not all European equities are cheap. However, we are comfortable with the valuation of high-quality stocks in our portfolio, many of which were forgotten during last year's value rally.

Third, this remains an under-owned asset class following significant outflows last year. Although we have seen a considerable pick-up in interest since the risk of Ms Marine Le Pen was dealt with so decisively, actual flows into the actively managed equity space remain limited as of now.

These three points allow us to be positive about European beta. Further, the market has generally been driven by stock specifics, which is positive from our perspective as there are times when the market is led by other factors. The collapse of stock-pair correlation this year bodes well for our fundamental investment process, and allows us to be positive about European alpha.

Q What would be your best advice for investors?

A With a dividend strategy, one effectively gets paid to wait. We identify companies that pay secure, reliable cash dividends that also grow over time. The benefit of this compounding effect is remarkable. Patience has its own rewards.

A version of this article appeared in the print edition of The Sunday Times on August 06, 2017, with the headline 'On the hunt for value in European stocks'. Print Edition | Subscribe