Nick Williams, Fund Manager of the Baring Europe Select Trust, reviews some of his most successful small to mid cap holdings.
European smaller companies have produced some of the best investment returns in the IMA universe over the past 20 years. The advantages of investing in smaller companies can often be overlooked, with the asset class frequently being dismissed as risky or illiquid. Over the long term, however, European small and mid caps have produced higher annualised returns for investors than those achieved by their large cap counterparts. In addition, according to research published by UBS, those higher annualised returns have been achieved with lower annualised risk than that of large companies, as the chart below* illustrates.
The “small companies” label undersells the fact that within the asset class there are many world leading companies. It is recognised that within Europe there are many small developing companies that operate in emerging industries which have the potential for high future growth. There are also numerous companies within the small and mid cap universe that are world leaders in their industry and with brands that are recognisable household names. Such companies include Amer Sports, the Finnish company behind sports equipment brands such as Salomon and Wilson, and Societe Bic, the French manufacturer of the world renowned disposable pen.
The European smaller companies universe is comprised of a dynamic pool of potential investments. Factors such as company management, strategic positioning or product innovation can enhance a company’s appeal from an investment perspective. The bottom-up investment process employed by the Barings small-cap team is designed to assist in identifying attractively valued, high quality companies that have potential to grow their profitability and deliver a high return on equity. The objective is to construct a highly active, balanced portfolio formed of the “best ideas” generated by the analyst team. The operational performance of these investments is then constantly monitored. Reviewing some of the team’s past investments is a useful way of demonstrating how the investment process functions, from time of purchasing a new holding through to the point of final exit.
Case study: Ryanair
Company management: Although Ryanair was already well established within the airline industry in 2011, the ambition of the management team to grow market share and expand the number of routes was impressive. Importantly, the disciplined approach to the company’s cost structure, and hence profit growth, gave confidence that the business plan would deliver shareholder value.
The Sector: Ryanair’s competitive position was excellent, with the airline serving around 25 countries in Europe. The company’s position was enhanced by our belief that traditional airlines were struggling under the burden of debt-laden balance sheets and out-dated business models.
Ongoing assessment: The investment was purchased in 2011. The initial share price target with all new holdings is for at least 40% upside within 9-12 months. Ryanair’s share price reached this target, and on reassessment of the investment case further upside potential was identified. A new price target was set and profit was taken as the share price continued to rise.
Exit rationale: The position was sold in 2014, after a further reassessment of the company. At this time the value of the company had reached c€9bn, which established the company firmly into the large cap universe. Moreover, challenges were emerging within the competitive environment from rivals such as EasyJet, Norwegian Air Shuttle and Wizz Air, which were expanding their fleet sizes and looking to gain market share by discounting prices.
Case study: Telenet Group
Company management: Telenet provide cable broadband services in Belgium. Its business comprises the provision of analogue and digital cable television, fixed and mobile telephone services. With a firm commitment to investing in the long term franchise rather than maximising short term returns, along with a strong execution record on both financial results and its strategic plans, the Baring small cap team held the company management in very high regard.
The Sector: The value of cable assets across Europe have gradually become more appreciated in recent years, with Liberty Global, a US company, acquiring a number of companies, including a majority stake in Telenet. Ongoing assessment: Telenet shares were bought in 2008 and held continuously until the position was sold in 2014. The company’s share price met the analyst’s target price several times during this period and with the subsequent reassessment of the investment case identifying further upside potential, the holding remained within the portfolio, although profit was taken on several occasions. The analysis revealed that the valuation awarded to the franchise in Belgium was underappreciating the quality of Telenet’s network relative to that of their competition. In addition, the scale of the potential cash returns to shareholders was not fully recognised in the share price.
Exit rationale: Whilst the shares had reached Barings’ increasing price targets in the past, the holding was eventually fully sold in 2014. The increase in control of the majority shareholder changed the dynamics of the executive team with potential to impact the company strategy. As the shares were valued at a price that was close to the target price and given that there were good opportunities elsewhere in the sector, the holding was sold.