Britannic Argonaut European Alpha Fund

We’re joined by Barry Norris who is the manager of the Britannic Argonaut European Alpha Fund. Barry, how have you felt about performance of the fund overthe last three months?

Well, we’ve been delighted with our start. We’ve made 21% for ourinvestors over the first three months and that’s some 8% ahead of the index.*

And to what do you attribute that performance, what are the key elements thathave caused you to have that success?

Well, a number of factors, I think first and foremost our stock picking ability; we’ve been very successful in picking individual companies which are cheaply valued but have got fairly good prospects, and so a number of those have performed very well over the first three months but we’ve actuallyheld them for longer than that.

When we last spoke, there was an emphasis in the portfolio on energy stocks,has that remained?

We feel that access to cheap energy is really the bottleneck to economic growth at the moment in the world and this is a problem and an issue which will be with us for a number of years, and so our overweight position in energy is really a very long-term thing. Essentially at the moment you’ve got demand for oil which is running at 84 million barrels a day but spare production capacity is only 1½ million barrels, and if you look at the oil industry how it’s invested, around half of oil produced today is produced from just 120 giant oil fields, and half of these oil fields were discovered more than 50 years ago and 95% were discovered more than 25 years ago, so I think what we’ve got here is an industry which has to spend more money to find moreoil otherwise the price of oil will keep going up and up.

And why is that particularly relevant to Europe as such?

Well, Europe’s got a lot of oil companies, it's got a lot of companies that operate in the global environment and we find a lot of oil companies which have got great prospects but more importantly are still not discounting thoseprospects in their price.

When we last spoke, you mentioned Findexa, and also I notice in your top 10there is Vinci in the portfolio. What’s the reason behind those?

Vinci has done very well. It's a company which I’ve held ever since I started running money in Europe. It's a company which more recently has benefited from the increase in profitability in French construction but also the fact that order books, they’re arising a double digit percentage year in year but also management have managed to create quite a lot of value in terms of motorway toll road and car park concessions. So Vinci is a company that we’re in for the long-term and we think that it offers very strong growth prospects with very limited downside. Findexa is a company which, as we’ve said the last time we spoke, we view of something of a valuation anomaly; it's a Yellow Pages company with a 12% dividend yield. Now we’ve had 3% of that yield, it pays 3% a quarter, and share price has appreciated somewhat as well, but I think it's fair to say that’s a fairly dull slow burner but certainly we will be happy if it continues to deliver a 3% dividend plus a capital gain every quarter. I think one of the best investments we’ve made over the last three months in the new fund is a stock that I’ve been investing in and been a big fan on for at least a year or so now and that’s a stock called TGS NOPEC. And TGS NOPEC basically does seismic surveys offshore for the oil industry. It tries to work out where the oil and gas is under the sea for the companies and then sells that data to companies that wants to drill for oil. Now TGS had not really done anything for the last year but we were still very confident that the company had some great prospects, and we were delighted when it came out with its second quarter results a couple of weeks ago where it's beat all expectations, even I admit our own, and the stock went up some 30% or so in two days. Now that’s still one of the largest holdings in the fund and we think there’s a lot more to come from the companyas well.

Last time we spoke there were 48 stocks in the portfolio as such and you spoke about the stocks fighting for their place, that you would have to remove the least best ideas, have any of those been removed over the last three months,your least best ideas?

Yes, there’s been a couple of ideas where we felt that although there’s value in the stocks, there’s a lack of catalyst on the horizon but will allow others to see the value in the same way as we see it, and whilst we’re prepared to invest over a long time period because these stocks are also competing for capital with other ideas that perhaps have got more near term catalyst,inevitably involves one or two of them losing their place in the first eleven.

And those have been?

One of them has been Swedbank in that we felt that the market has underestimated the company’s growth potential in the Baltic regions, it made an acquisition of Hansapank which is a very high quality company in Estonia, and we felt the company traded on a very cheap multiple which didn’t really reflect this growth, but the Swedish banking system is not and the economy is not really offering much in the way of top line growth for the company, so we think it’ll probably take a bit longer and it’ll take a bit longer in terms of the Swedish economy offering that growth for the share price to really start toappreciate.

One of the reasons that you said that a stock would be removed from the portfolio is that if you had actually got something wrong. Have you actually got anythingwrong?

Well, I think there is one investment which we made where we found the industry particularly attractive and we found other companies in the industry attractive and they were already in the portfolio, and that’s the agriculture industry. And there are a number of investments that we’ve made there both in terms of fertiliser companies, crop sciences companies and indeed companies that produce soft commodities themselves. We think that that’s a very powerful story over the next couple of years as the world population grows but also people living and developing economies basically swap carbohydrates for meat in their diets as they grow richer and that creates a demand for more intensive agriculture. Now one of the companies that led us to look at was a Finnish company called Kemira Growhow which produces fertiliser, and we felt that the company traded on a very cheap multiple and there was a very dividend there. However we were pretty disappointed with the company’s last set of results. There seemed to be, this seems to be a company which has been plagued by a bit of bad luck. For instance a squirrel got into one of their power generators and blew it up resulting in a £1.5m hit to profits in that part quarter. Hopefully they’re not going to come across those sorts of squirrels that often. But essentially the company has some problems in terms of accessing cheap energy, and because the price of gas, particularly in the UK where it's got a lot of its plants, has gone up so much, they’ve been unable to pass on that price of gas sufficiently in the price of fertiliser, and we felt that there are other companies in the same sector most, obviously Yarra whichare much more better placed to do that.

Okay, tracking error, the elements of risk within the portfolio, trackingerror and beta, on target for you?

Yes, I think, well as you know we monitor these things but we’re not dictated by them. The tracking error is 5½% at the moment which we’re a bit uncomfortable that that’s too low in that we obviously need to take a fair amount of risk against the benchmark in order to outperform it, so we’re delighted to have outperformed it by 8% or so in the first three months of only a 5½% tracking error. But there’s some school of thought which suggested that tracking error is being underestimated because volatility in the market is just so low, but nevertheless because volatility is so low that’s obviously making it more difficult to outperform for more people. Beta is still less than 1%, we’re not taking, we think, huge amounts of risk in terms of capital loss in our investments, and we’reobviously delighted with that.

And the current shape of the portfolio as it stands today, how would you describe that, major underweights, overweights versus the MSCI ex-UK,Europe ex…?

Major overweight oil which we’ve talked about, we think we’re closer to the start than the end of the boom in oil in oil stocks. Another overweight is industrials. We’ve got a lot of ideas, particularly inconstruction.

And in France?

We think that the French are undergoing something of a house building boom at the moment, and there are lots of companies there which we think look like UK house builders did five years ago, ie interest rates are likely to stay low for a considerable period of time, there’s under ownership of housing, prices have started to appreciate quite rapidly and you’ve got the French Government which is really encouraging house building and new activity as well. There are a number of companies that have got very very strong order booksand cheap valuations.

And how does the portfolio stand geographically?

Clearly there’s been a lot of noise recently that there’s a recovery in the German economy and a lot of fund managers are starting to talk aboutGerman stocks offering cheap valuations and good growth prospects again.

And investor sentiment?

Exactly, but we think that that’s rather an easily mouthed consensus view at the moment and there’s not much concrete evidence that the German economy itself has got the sort of domestic demand that would stimulate a period of more rapid economic growth there. The German economy remains very dependent on the export sector. And although the companies have done very well in taking a bigger share of GDP, we’re not yet confident enough that in the long-term prospects in terms of demand stimulation of the German economy and we certainly can’t find a whole host of individual companies that we think are attractive. On the other hand, we’ve made our first investment in Turkey over the last couple of months. We’ve bought a Turkish bank called Akbank which is very well capitalised, probably the lowest risk Turkish bank that you can find in terms of balance sheet. It's a very well run blue chip company and we think that it offers tremendous growth in terms of capturing the demographics of the young population in Turkey and obviously you’ve got a very under penetrated population in terms of financial products. Not very many people have a mortgage, a credit card, a personal loan, and so we think that’sa great area to be over the next decade or so.

And where else are you looking?

Well, France remains the biggest country weighting in the portfolio but the second biggest country weighting is Norway, and as Norway’s a very small part of the index, that is our biggest overweight country position and essentially the Norwegian economy is booming, it's going to grow at 3½-4% this year, interest rates over the last couple of years have come down from 8% to 2% as the Central Bank there just tries to control the appreciation of the currency, the country runs a trade surplus of 13% of GDP so the currency appreciation there and the strong fundamentals in the economy are well backed by this favourable trade position, but we’re just really spoilt for choice in terms of the number of companies that have both got excellent growth prospects and trade on cheap valuations there. And I think the Norwegian market has historically been a market on the periphery where mainstream investors have shied away from it partly due to corporate governance which we think has improved but partly because it's never been a very big part of the index, but we think that because we’re prepared to look in these places that we’ve got a littlebit of an advantage there.

What about those places that on your inspection you actually wouldn’ttouch with a barge pole, the major underweights?

Well, potentially, the fund could invest in Russia, and indeed a couple of years ago I had invested in Russia, but we feel that Russia has really failed to make the transition from a command economy albeit one which is very well endowed with natural resources to a property earning democracy, and we still think that those property rights are important as an equity holder and we think you have to have a massive risk premium to invest in Russia. And we’re also concerned that the Russian oil industry is really struggling to grow production because nobody really wants to commit any capital there because they might not get it back, it's not really got much in the way of infrastructure to export the oil anymore and indeed the Russian Government is making noises that it doesn’t want, it wants less crude to be exported and more finished product, which is obviously going to bring the level of exports down. But also the tax regime is such that the oil companies have to pay 90% of their profits away above a certain level, so the companies there are not so much geared to theoil price as companies that we can find in mainstream Europe.

Is there anything currently that’s actually worrying you about Europeand European companies?

Yes, I think the Central Bank often gets a fair deal of criticism which is unwarranted. Their job is, as they see it, certainly is to keep the price of money steady, and they’ve done that very well. And arguably Central Bank shouldn’t be trying to micro manage the economy in the same way as the Central Bank in the UK and the US does. Where they’ve taken a lot of unwarranted flack is it's up to the governments in Europe to really try to reform the economies to get more flexible labour markets, less red tape to allow businesses to grow and with the exception of a few countries, have not really done that, so I think more blame on the governments and less on theeasy scapegoat of the Central Bank would be the order of the day.

Now let’s move back to the fund itself. Net inflows, how’s itactually doing?

Well, we’ve been delighted with the first three months because we’ve raised around £75m and that makes the fund one of if not the best selling unit trust in the UK over the period. We’ve been delighted with the fact that most of my investors previously have followed me to Argonaut. We’re delighted that Britannic have been able to fully commercialise our investmenttalents.

And how about your relationship with Britannic, after all that organisation has gone through a number of changes since you became a boutique within theirumbrella as such?

We’ve been delighted with the support we’ve got from Britannic so far, it's an organisation with a lot of very talented individuals, and I think it's important for a boutique to be well supported, well financed bya parent company that has obviously got a lot of resources.

And have there been any changes to the management team at all that peopleneed to know about?

No, the team remains just Oliver and myself, and I feel that that’s more than enough for now, but as we come to launch new products then perhapswe’ll look to add a couple more people selectively.

And is that actually on the horizon?

Well, we’re planning in the fourth quarter to launch a European income fund, and we think, as we’ve spoken about before, that dividends are one of the most attractive aspects of the European market at the moment. And of course income products are very popular in the UK retail world. We think that we can offer a fund which is a dividend yield of 6% which is sustainable and that income stream will grow over time, I think that will compare favourablywith similar products in the UK market.

Okay Barry, sum it up for me?

Well, I think the fund continues to offer very good prospects for capital gains. Despite making 21% over the first three months,* we’re certainly not short of money making ideas, so I think prospects for making money in Europeremain excellent.

Barry Norris, for the time being, thank you very much.

Past performance is not a guide to future performance. The value of unitsand the income from them can go down as well as up and is not guaranteed.

*Source: Lipper, bid to bid, net income reinvested from launch to 12 August 2005. The Britannic European Argonaut Alpha Fund was launched on the 12 May 2005.

Information and opinions contained in this interview have been compiled or arrived at by Britannic Asset Management Limited. Britannic Asset Management Limited and Asset.tv Ltd accept no liability for any loss arising from the use hereof nor make any representation as to their accuracy or completeness. Any underlying research or analysis has been procured by Britannic Asset Management Limited for its own purposes and may have been acted on by Britannic Asset Management Limited or an associate for its or their own purposes.

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