Last updated: 13:57 / Friday, 5 January 2018
Interview with Richard Halle

M&G: "The Valuation Gap Currently Between Value and Growth Stocks is Almost as Wide as it Has Ever Been"

M&G: "The Valuation Gap Currently Between Value and Growth Stocks is Almost as Wide as it Has Ever Been"

Richard Halle, portfolio manager of the M&G European Strategic Value Fund believes that the context is favorable for value investing in equities. In his interview with Funds Society, he explains that the economic recovery environment in Europe, together with the reduction of political and macroeconomic uncertainty and the increase in interest rates, should turn the situation and prove beneficial to this style of investment.

What are the main arguments in favour of investing in European equities?

European equities look attractively valued, in our view, both in absolute and relative terms, particularly compared to US stocks. In addition, European companies should benefit from the region’s economic recovery which should support earnings growth. Economic growth has picked up, unemployment rates have fallen across the eurozone and inflation has started to rise. The European Central Bank has arguably provided the necessary support to revive the eurozone and investors are now focusing on how the stimulus measures will be withdrawn.

You apply a value investing approach…how easy (or hard) is it to find undervalued companies in Europe?

While the overall market has risen this year, we think there are still plenty of opportunities for selective value investors. In our view, value stocks are attractively valued on both a relative and absolute basis.

Value as a style has been out of favour for several years as investors have favoured growth stocks with reliable earnings and ‘bond proxies’ offering steady income payments. The value recovery in 2016 proved to be short-lived and investors have preferred growth stocks this year. As a result of this prolonged underperformance, the valuation gap currently between value and growth stocks is almost as wide as it has ever been. If this gap were to narrow we think the potential rewards could be significant.

More recently, we have been finding value opportunities right across the market, rather than concentrated in particular sectors.

Is it necessary to hold cash in case better opportunities arise?

As value investors who are looking for mispriced opportunities to arise we tend to have a slightly elevated level of cash in the portfolio. This is so we are able to take advantage of short-term volatility and mispriced stocks.

What is the potential upside of your current portfolio? With the recent stock market rally…has this figure decreased?

We think there are plenty of stocks in the portfolio whose prospects are being significantly undervalued. While a number of our cyclical holdings have performed well recently as investors have become more optimistic about the outlook for the European economy, we continue to believe that the portfolio still has several cheap stocks that are being mispriced. In terms of valuation, the fund is trading at a significant discount to the MSCI Europe Index (on both price to book and price to earnings metrics).

Are you expecting a market correction in the medium or long term that could benefit your strategy?

In recent years, value has underperformed as investors have sought defensive ‘bond proxies’ amid uncertainty, volatility and ultra-low rates. Looking ahead, we believe the continued recovery in Europe, a reduction in uncertainty (both political and macro) and rising interest rates should be beneficial for a value approach.

How do you harness volatility episodes in your management strategy, such as the recent French elections of the future elections in Germany?

As long-term investors, we see uncertainty and the volatility it can generate as a source of opportunity rather than something to be feared. When sentiment rather than fundamentals drives markets, stocks can often become mispriced. As long-term bottom-up stockpickers we would try to take advantage of any valuation opportunities that present themselves in these situations.

Sectors and names: how are you positioning your fund now? Which sectors are you overweighting and why?

The fund’s sector allocation is an outcome of our bottom-up stock selection process rather than top-down views. Nor do we take high-conviction positions in individual stocks. The fund is limited to a 3% weight in stocks relative to the MSCI Europe Index. As a value fund, the value style is expected to be the main driver of fund performance rather than bets on particular stocks or sectors.

Having said that, we have been focusing lately on finding attractively valued opportunities that could benefit from the European recovery. We have been adding to a number of our more cyclical holdings, including Bilfinger, a German engineering and construction company, and Randstad, a Dutch recruitment firm. We have also invested in Wereldhave, a Dutch real estate company that invests in shopping centres.

At the sector level we have overweights in consumer discretionary, industrials and energy. In contrast, we have underweights in consumer staples (an area that we believe is expensive as investors have sought the perceived safety of defensives in recent years), financials and materials.

Even though we have a below-index position in materials, we have been adding to our holdings in stainless steel makers Aperam and Outokumpu, which we believe have attractive prospects given potential demand for steel.

Banking sector: many fund managers are staying on the sidelines. Are you following the same strategy or not? Why?

We have an underweight in financials which is due to an underweight in insurers – we think the current environment is difficult for them to grow their earnings.

However, we have been investing in individual banking stocks lately. For instance we have a holding in Bank of Ireland, which we believe is well positioned to benefit from the improving economic situation in Ireland. Another recent purchase holding is Erste Bank, Austria’s largest bank by market value. In our view, Erste Bank has strengthened its balance sheet recently and is arguably now well placed to benefit from stronger economic growth in Europe.