Fund manager sees investment opportunities in Europe
European economies have been battered by seemingly never-ending crises: first Greece’s overwhelming debt, then trouble in Ireland, Portugal, Spain, Italy and beyond. So why would anyone want to invest there?
David Nadel, director of international research for the $36-billion Royce Funds, sees opportunity in the struggling region.
The 42-year-old investment strategist said one key to making profitable investments in Europe is focusing on companies that sell their products worldwide, especially to customers in emerging markets. That makes them less dependent on European consumers, he said.
Nadel is portfolio manager for six Royce funds, including its Global Value and European Smaller Companies funds, which each have three-year annualized returns of about 13%, beating most of their peers over that time span.
Q: What is your strategy with European markets, given the long-term nature of the financial crisis and problems with the economy?
A: What we like in the region is that you can find really high-quality companies with very long operating histories, strong market shares in niche sectors and experience operating in a global way. They’re getting a lot of their growth from emerging markets. We like this mix of getting the developed-world management teams with first-world standards of corporate governance, but getting revenue sources largely from emerging markets. That’s been a big part of our strategy.
Q: If growth is going to be negative or slow in Europe for some time, isn’t it a red flag to stay away?
A: There’s no question that growth has slowed and will continue to be challenging in parts of Europe. You also have some real success stories in Europe. Germany is the obvious case. It’s an export economy. The Germans are famous for making products the world wants, whether it’s cars or anything else that’s engineering-driven, cleverly designed. Switzerland is in a good spot. It’s an economy that pushes above its weight. We find a higher concentration of world-class companies in Switzerland than anywhere else we invest in.
Q: What are some European companies you like?
A: One is Pfeiffer Vacuum in Germany. Their products are used to create a pure environment in the production of semiconductors, healthcare products and other things. We have an investment in both funds in Victrex, a U.K. company that makes the world’s most sophisticated type of plastic, PEEK. It’s lightweight and high-strength. It’s used as a metal substitute in the Boeing Dreamliner plane. Only 2% of its revenues come from the U.K., so 98% comes from exports. We have definitely tried to focus on the European companies that are global businesses.
Q: Is now a good time to buy, sell or hold European stocks?
A: I think it’s still time to hold for the long term. We have been adding a little bit. Royce definitely takes a contrarian approach. So it’s not a huge surprise to hear that we’re adding things that are out of favor. We don’t think it’s time to sell European stocks, because the region as a whole is trading at valuations that haven’t been seen since the early ‘80s.
Q: How do investments in European companies compare with the rest of the world?
A: We like Europe as a place to invest, so long as the companies are globally minded. You have a political challenge, a currency challenge, a sovereign-debt challenge that is more severe than pretty much any challenge anywhere else in the rest of the world. But I also think it’s all getting too much attention in terms of headlines. If the stock market blows up tomorrow, it’s not going to be because of Greece. We’ve known about Greece and have been over-analyzing Greece for two years now.
Q: European stock markets have fallen recently but are still above their June lows. Do you think Europe bottomed out in June?
A: I don’t think anyone can have confidence that’s going to be the low. Eventually, the most dire situations resolve themselves, that I’m confident about. I’m not confident about that for the next two quarters.
Q: Is there a danger that Europe has become a “value trap” in which stocks look cheap but just keep getting cheaper?
A: There is a danger that some sectors in Europe have become value traps. I would stay away from the banks — they have become cheap, but I haven’t met anyone who knows what’s inside these banks in terms of toxicity of their assets. That is a recipe for disaster. We try to focus on companies that are proven and understandable and less likely to become value traps.
Q: What do you think the chances are that the Eurozone will break up? And would that be catastrophic for European markets?
A: I don’t think it’s a high near-term probability. The odds are higher it breaks up the longer you go out, in terms of time. Most likely it would not happen all at once. It would be one country exiting and then maybe another, one year later. I don’t think it would be that terrible for the markets. If the euro begins to collapse, it’s definitely not a blindside. It’s a possibility people have been pondering for some time.
Q: Dividend yields on many European stocks are much higher than U.S. yields. Are dividends an investment focus of yours?
A: We don’t target companies with dividends. We target companies with high returns on invested capital and strong balance sheets. They’re the types of companies that almost embrace challenging economic times. They tend not to be survivors but thrivers in challenging times. They also tend to be reliable dividend payers.
Q: Do you see any risk that the euro currency could fall dramatically? Do you hedge the currency to protect against that possibility?
A: The euro may weaken further against the dollar, but I don’t view any paper currency as being a reliable measure of value. The U.S. dollar has lost 98% of its purchasing power in the last 80 years. We don’t hedge with dollars, but we do hedge a little bit by having an overweight position in hard assets, anything in finite supply. Gold and silver mining companies are a natural hedge against currency weakening.
Q: Your European smaller-companies fund and global value fund performed well compared with others in the sector in 2009 and 2010, but not as well in 2011 or this year. To what do you attribute that?
A: We have a very distinct style. We focus on higher-quality companies. Higher-quality companies don’t always outperform. In shorter periods, they can underperform. In the case of the global value fund, we have been significantly underweighting the U.S. compared to the index and that’s hurt the performance in the short term. We continue to think there’s too much money chasing stocks in the U.S. and not enough money chasing stocks in Europe.
