By Hamlin Lovell, NordicInvestor
“The mission of our team is to invest in good companies with a competitive edge, which could be in technology, or culture; which have the global reach to sell outside Europe; which are recession-proof and so not vulnerable to downturns, and which are generating strong profitability, return on capital and free cash flow”, says lead portfolio manager, Pascal Riégis. He recognizes that there is huge valuation dispersion between growth and value stocks, but does not divide the market in this way and has no style or factor bias. “The only relevant distinction is between companies that do have a competitive edge and those that lack it, and we will never buy the latter category – however cheap or fashionable or at risk of takeover they may become”, he says.
European small and mid-cap stocks, as an asset class, have been a good investment over the time, mostly outperforming large caps: over the past five years ODDO BHF Avenir Europe has been up by 9,8% annualised compared to the official benchmark (MSCI Europe Smid Cap Net Return Eur.) which was up by 7% annualised over the same period (data as of Sept, 2019) : active share is currently around 95% and has always been over 90%, as the manager’s stock-picking criteria are very selective.
“This distinctive investment philosophy could be applied to large, mid or small cap stocks. The main advantage of mid-caps is that there are more companies to choose from: around two thousand, compared with only a few hundred large caps. Other advantages are that smaller companies have more growth potential, are often more innovative, display a wider variety of business models, products and services, and have not yet diversified through acquisition”, he adds. But ODDO BHF Avenir Europe is not invested in microcaps – its median market capitalization is EUR 7.7 billion and ODDO BHF AM manages EUR 6 billion in several small and mid-cap strategies.
The approach outperformed the benchmark in most calendar years, and often held companies for many years: portfolio turnover has averaged only 30% per year. The team of four have also been together for a long time, since July 2003. The periods of greatest outperformance have included 2008. The sharpest underperformance was seen in 2013, though this was still a very strong year in absolute terms. The strategy lagged indices in 2013 because market leadership of European equities in 2013 came from domestically focused stocks, which the strategy has very little exposure to: in July 2019 it had no exposure at all in telecoms, oil and gas, utilities, or basic materials. “2013 marked the end of the European sovereign debt crisis, and the risk premium on European assets disappeared. Telecoms, utilities, construction, retailers and financials were driving the bull market”, recalls Riégis. Two other macro factors were headwinds: a stronger Euro currency was seen as challenging for export-oriented companies, which were also out of favour because a number of emerging market economies were moving into their own crisis phase. The revenue split of ODDO BHF Avenir Europe’s holdings in 2018 was c 45% Europe, c 30% North America and c 25% rest of the world.
The strategy has been consistently overweight of healthcare, industrials and technology, and its stock picks are mainly listed in Northern Europe, France, German-speaking Europe and the UK. It has very little exposure to Southern European countries such as Spain and Italy, as very few publicly listed companies in these countries fit the criteria.
Healthcare holdings have ranged from Irish-listed clinical trials group Icon, to French oncology group Ipsen, to German ophthalmology and microsurgery specialist, Carl Zeiss Meditec, and Hungarian drug maker, Gedeon Richter. In the industrials segment, aircraft engine makers, Safran and MTU, are two examples of firms that have generated spectacular shareholder returns. In technology, the strategy holds Czech cybersecurity firm, Avast (which is listed on the London market).
Sector labels are not always a good guide to Riégis’s stock picks however. For instance, under basic materials he has held a position in Dutch vitamins maker, DSM while the energy position includes oil services engineering companies rather than oil producers. These stocks do not display the typically cyclical profile of basic materials or energy.
For a Nordic audience, we want to highlight a couple of locally listed stocks. “Denmark’s GN is a world leader in hearing aids, highly profitable, and gaining market share. They are also innovative, interconnecting the hearing aids with smart phones, and remote controls, and doing so more smoothly and efficiently than competitors. The firm is also branching out into videoconferencing, with a triple camera solution”, he says. “We recently bought into the security industry for the first time. Historically, we viewed this as a commoditized and very competitive industry, but now the business model is changing as technology is giving some companies a competitive edge. Proprietary technology is being used to count money and read passports, and this creates a barrier to entry. The big players can innovate and consolidate and the smaller ones will lose out. We own Sweden’s Securitas and the UK’s G4s”.
The UK weighting is now up to 17% as Brexit fears have helped to create value in the UK market; some years ago, when European stocks traded at a discount to UK stocks, the UK weighting was as low as 5%.
ODDO BHF AM was an early mover on ESG and manages EUR 6.9 billion incorporating ESG criteria, in equity and credit strategies (data as of Sept. 2019).
From the inception of the fund ODDO BHF Avenir Europe in 2003, five sectors: Tobacco, Alcohol, Gambling, Coal industry, Nuclear, were excluded. This has also been determined in the prospectus in 2019. These make up less than 10% of the small and mid-cap universe.
The investment research process also includes much more nuanced analysis of sectors and sub-sectors. “Taking insulation as an example, glass wool and rock wool are viewed as environmentally unfriendly materials, but plastic derivatives produced by an company, based in Ireland – which plans to recycle one billion plastic bottles per year by 2025 – are seen as cheaper, lighter and less energy intensive. ESG is not black and white, there are many grey areas where we exercise judgement”, explains Riégis. Thus ODDO BHF AM develops its own ESG scores for companies, using inputs including Sustainalytics, CDP, Bloomberg, and Factset. The ESG score weightings can range between 10-30% E, 40-50% S and 30-45% G, depending on the company.
ODDO BHF AM SAS has been a signatory of UN PRI since 2010, and complies with the Ottawa Treaty 1997 and Oslo Convention 2008 on arms and weapons.
ODDO BHF AM takes care to vote its proxies, engages with “high risk” ESG companies, and may divest positions if such companies do not improve their policies.
ODDO BHF AM SAS also belongs to the Climate 100+ initiative, and the fund ODDO BHF Avenir Europe has a carbon intensity well below that of the Stoxx 600 index.