03/02/17

US hedge funds start to bet big on Europe

With their rivals distracted by the drama of US politics a small but growing number of hedge funds are increasing their exposure to one of the least fashionable markets in the world — continental Europe, reports Financial Times.

“American investors have pretty much given up on Europe,” says Joseph Oughourlian, founder of the $1.5bn activist hedge fund Amber Capital. “Europe is seen as the big loser in the current geopolitical trend. People feel [Donald] Trump is almost openly in favour of the disintegration of the European Union and that Brexit is just the beginning”.

As nimbler alternative asset managers seek to increase their exposure to European assets, with early buyers having booked big gains for 2016, a broader base of mainstream fund managers appear unconvinced. The most recent Bank of America Merrill Lynch’s monthly fund manager survey, which polls investors controlling a total of $547bn of assets, shows that Europe remained significantly less favoured than the US. The survey’s measure of sentiment towards the single currency remained at rock bottom.

Fundamental valuations, however, suggest that consensus opinion on Europe may well be too negative. European equities have rarely been as cheap when compared to the rest of the world, according to Northern Trust. With many fearing the political risks hanging over Europe while embracing the idea of the so-called “Trump trade” the valuation gap between stock markets in the US and Europe has remained wide. The US S&P 500 index currently trades at a forward price to earnings multiple of over 17 times, compared to less than 15 times for the pan-European Euro Stoxx 600 index.

This gap has spurred concentrated, bottom-up equity-focused investors to buy up shares in European-listed companies, especially those in Southern Europe, that have large amounts of their business based in North America, but are still arguably penalised for being “European companies” by the market.

For early buyers, who have already benefited from identifying very profitable opportunities, the outlook still remains attractive. Mr Oughourlian‘s Amber activist fund generated returns of 17 per cent last year, and he has continued to build positions in companies across Southern Europe. “I personally think these fears about Europe are being overplayed and are offering up some compelling investment opportunities,” he says.

US value investor Southeastern Asset Management’s Concentrated Value Europe-focused fund, backed by Egyptian billionaire Nassef Sawiris, returned 30.5 per cent in 2016. These gains were helped by a large stake in the industrial testing company Applus, which although is listed in Spain derives over a third of its revenues from the Americas and a quarter of sales from Asia, the Middle East and Africa.

The Applus investment followed a pattern of searching out bargains in Europe, which eventually revert to trade at valuations closer to their US peers. At the start of 2015 Southeastern began building up a large position in Adidas, which traded at a significant discount to US rival Nike, with the German company’s shares tripling in value in just over two years.

While shares in US companies exposed to greater government spending on infrastructure and higher inflation have been sought since the election of Mr Trump, the market appears less convinced this thesis will play out in Europe. CRH, the construction materials manufacturing company, is nearly flat since the US election, as is HeidelbergCement. Shares in the London-listed Ashtead, an equipment rental company with a significant business in the US, however have surged by a third since the vote.

Yet it is not only stock pickers that are seeking out opportunities in Europe but also debt specialists, some of whom are raising money from investors in the belief that the continent is less crowded than in North America, and attractively valued. Avenue Capital, the $10.6bn New York-based fund that focuses on distressed investing, is currently fundraising for a European-focused fund that will seek to buy up senior debt in Western European companies they deem financially sound while undergoing difficult periods.

Others are moving more of their assets away from the US and into European investments. Jason Dillow, chief investment officer of the New York-based $9.2bn Halcyon Capital Management which invests across equity and debt is another who is also increasing his fund’s exposure to European assets. Between 15 and 20 per cent of Halcyon’s credit exposure is in Europe at the moment and Mr Dillow expects that to rise this year. “I do expect us to go higher,” he says. “There are lots of these niche, under-loved and underfollowed opportunities in Europe today.”

Victor Khosla, founder of Strategic Value Partners, a $5bn fund with both private equity and hedge fund strategies, says he currently holds about 60 per cent of their exposure in Europe at the moment, compared to 40 per cent in the US. He believes that ongoing noise about politics in Europe could create attractive entry points for longer-term focused investors.

“When we invest in the US, it’s like fortress America but when you look at Europe, there are all these fissures, all these cracks running through the system, whether it’s the Scottish referendum, or Brexit, or Italy. There are always these breakpoints in Europe that create issues. If you’re an investor like us, it creates some really interesting opportunities.”