despite fillip from strong-performing tmt sector five years ago, funds failed to take advantage of rallies in high beta stocks as managers took defensive positions
Funds that performed well in the Equity Europe ex UK sector in the past five years did so on the back of the TMT boom. However, most managers seem to have missed subsequent rallies in high beta stocks and were defensively positioned throughout the bear market.
The GAM Star Continental Europe portfolio was the top performer in the Equity Europe ex UK sector. Manager Maria Llamas claims her strategy has not changed over the past five years. She tries to pick firms that are restructuring or are reducing operating costs where investors are likely to see a change in the return on capital.
One period where the portfolio performed extremely well was during the TMT boom. Llamas says: "We spotted the TMT rally early following the liberalisation of the European telecom market. We got out of the sector quickly before the bubble burst and shifted the portfolio into old economy stocks."
Although the portfolio did suffer and fall back during the middle of 2000, Llamas points out this was because she position the fund back into cash and more defensive stocks such as old economy when the market did not like it.
According to Llamas you sometimes have to build positions that may initially hurt the portfolio in the short term when the sector is going down, but should pay off in the long term.
The move did pay off and the fund performed extremely well in the third quarter of 2000 when old economy stocks came back into fashion.
Around the second quarter in 2003, the GAM fund fell with the market following the Iraq war. However, the portfolio was positioned in defensive stocks and cash, and when the market started to improve it was the high beta stocks that rallied. The fund did not catch all of the upside, although Llamas did switch into financials where some outperformance was achieved.
From September 2003 Llamas' fund has been performing well on the back of oil stocks. She recognised that oil price was at low values and the world was becoming more dependent on oil following strong periods of growth. Llamas thought oil stocks were too cheap and foresaw the rise in the price.
"We believe that there is structurally higher oil demand and plentiful supply but it is becoming more expensive to get that supply out of the ground and into the market. That has the effect of tightening the market and increases the price of commodities," Llamas says.
The Henderson HF Continental Euro Equity fund was ranked the second top performing fund in the Equity Europe ex UK sector. John Botham, director of European equities, says: "The key to performing well is our flexible approach. We were correctly involved in the hype of the TMT sector. At Christmas time in 1999 we correctly identified when they were getting over valued and cut back extensively."
Despite the fund's good performance, Botham is quick to point out instances where it could have been better. He says 2001 was a disappointing year. Although the bursting of the TMT bubble was correctly identified, he did not anticipate the general downturn in the equity markets. When the Fed started to cut interest rates, the Continental Euro Equity portfolio started to go back into cyclical stocks. This positioning proved to be misplaced.
In 2002, Botham became more conservative and put more money into pharmaceuticals and food manufacturers. But he did not get involved in small caps, instead focusing on mid- to large-cap stocks. Although he achieved good performance in the middle of 2002, for most of the year it was the small- to mid-cap stocks that rallied.
The Henderson fund again fell back in 2004. Botham says: "We were optimistic about the economic recovery and thought it would be longer than anticipated and had a large under weighting in utilities. This was wrong."
Botham thinks to be able to achieve good performance it is important not to be too dogmatic and to change when things go wrong.
The Thames River European fund, managed by Tony Zucher, also performed well over a five-year period and was ranked fourth out of all the portfolios in the sector.
According to Edward Morse, director of sales at Thames River, the key to the good performance of the fund is the bottom up stock-picking process. This strategy focuses on companies that have been influenced by some sort of change that will make a difference to the share price. Zucher is also prepared to get out of positions quickly when the situation changes.
From time to time the portfolio has been positioned quite aggressively. It was first launched in 1999 where it also had a major overweight in the TMT sector during the boom. Although Zucher was successful at cutting back weightings in the sector, when the market peaked it missed subsequent rallies during the bear market.
Morse says: "During the bear market the portfolio was underweight high beta stocks such as financials and TMT, but missed out on the significant rallies that occurred in these areas. This could explain some down performance at the end of 2000 and early 2001. For most of this period the portfolio had defensive positions and was overweight utilities and oil stocks."
After September 11 the portfolio did not catch the sharp rebound in the financial and TMT because of its defensive overweighting. In the summer of 2003, Zucher increased exposure to cyclicals as there was a bounce in the market following the Iraq war. However, he was a bit late in the rally and the more bearish positioning had an impact on the performance.
The Old Mutual International European stock market funds did not perform well over a five-year period. The bottom five funds were made up of Old Mutual International portfolios. A spokesperson from Old Mutual International was unavailable to comment.
The aim of the European stock market funds is to generate long-term capital growth through investment in continental European equity markets. The manager aims to invest in securities that are undervalued relative to the market, or with high levels of potential for capital appreciation.
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