T. Rowe Price European Smaller Companies Equity Fund
PRESENTER: Justin Thomson is manager of the T. Rowe Price Funds SICAV - European Smaller Companies Equity Fund, and he joins me now. Justin, what are valuations looking like in the sector?
JUSTIN THOMSON: In the context of the very low interest rates we have in Europe at the moment, they’re good value. Earnings yield of 5½%. That compares with corporate bond yield BBB of 4½%, so in the context of that they look good. If I reverse that earnings yield and say that the sector overall is on an 18 times multiple, put that in historical context, 25-year average is 14 times. So on one-year forward earnings they look a little bit expensive. However, Europe is down on its luck; the ‘E’ in that equation, the P/E equation, is depressed at the moment. So arguably if I cyclically adjust and I call it a price-to-book, it’s on a price to book of 2.2 times, in line with the 25-year average, valuations generally are supportive.
PRESENTER: How does that look against European large cap?
JUSTIN THOMSON: European large cap is cheaper than small cap. Bear in mind that it’s dominated in Europe by a number of mega caps, be it big integrated oils, be it very large banks. That in the banks’ case they’re structurally challenged or in the oil majors cyclically challenged, that brings down the whole large cap sector. So they are still looking marginally expensive versus large caps. If we were having this interview this time 12 months ago in 2013, which was a great year for small caps, they would have looked much more expensive. 2014, they underperformed, gave some of that premium back.
PRESENTER: What’s liquidity like in small caps?
JUSTIN THOMSON: Liquidity comes and liquidity goes; it is a cyclical sector and demand for it is cyclical as well. Now bear in mind the way we manage this strategy: (a) we’re diversified and (b) we are long term. And we are long term for a reason, because to be successful running small companies you need to be thinking long term and you need to be minimising your transaction costs, and we do that by trading as little as possible and extending our time horizons.
PRESENTER: And how does that potential lack of liquidity affect how you put a portfolio together?
JUSTIN THOMSON: It’s a good question, and the strategy that we’re talking about, which is our European Smaller Companies Fund, it tends to be a diversified fund. So at the moment we’re holding 91 stocks, so it’s quite a diversified fund, that’s the first point. Second point, if we’re to do a good job for clients on the long term in an illiquid asset class, we need to minimise our transaction costs, and do we that by thinking long term, by keeping our trading to a minimum, and therefore keeping our trading costs to a minimum - very very important.
PRESENTER: So what’s the average holding period for a stock?
JUSTIN THOMSON: We want to think about a stock on a three-year view minimum; in some cases, we’ve held stock for over 10 years. What is the optimum time period for a really good durable growth stock? Hold it forever!
PRESENTER: Where do you see the best investment opportunities today?
JUSTIN THOMSON: As always with the strategy, we have a very wide and very disparate set of opportunities. And because we’re trying to create a portfolio that will perform in different market cycles, we try and blend the risks, and blend the type of companies that we are owning from some very young to some much more mature businesses to some restructuring plays, and that’s how we tend to delineate the investments we make. And I’m going to give you an example from each one.
The first one would be in the very early lifecycle businesses that we own. It’s a software business. It’s called WANdisco (Wide Area Network Distributed Computing). They have a piece of software for handling big data. And if you think that the volume of data that corporations are handling is growing at 60%, but we think budgets are only growing at 5%, there has to be some serious thinking done here. WANdisco’s technology is disruptive. It is very early lifecycle, it’s not proven, it’s not yet profitable, but we believe in their technology and we believe that this is a 10-year mega trend. That’s the first example.
Second example being a much more mature business, in this case the company is over 150 years old. It’s a group of Swiss trading companies trading in the Far East, and what they do is they help companies, multinationals mainly who want to establish themselves in the emerging markets of East Asia. It helps them set up their business, market and distribute their funds and collect their receivables. The stock’s name is DKSH. You get the benefits of the emerging market consumer, we think can compound at about 10% top line, and you get that within the framework of Swiss corporate governance and Swiss dividends.
Last but not least would be a restructuring play, and the example I’m going to give you is a UK list regional airline called Flybe. Now Flybe has been operationally challenged for many years. They’ve recently had a wholesale change of management. They have recapitalised the balance sheet with the help of our funds. They have changed the way they manage the business entirely. They’ve improved the yield systems. They’ve improved the route network. And with the benefit of falling oil price and improving UK regional economies I think this is a very strong investment case.
PRESENTER: Why add European small caps to an overall investment portfolio?
JUSTIN THOMSON: The benefits of diversification, the benefits of dispersion of returns, it’s a huge and very broad asset class. Over 2,500 stocks, the dispersion of returns every year are great. And I’m here to sell bibles rather than a religion, and that’s why you need a good active fund manager to take advantage of those dispersions. And last but certainly not least, just the breadth of opportunity, great growth opportunities, some of which I’ve just alluded to.
PRESENTER: What would your core message be to anybody thinking of investing in this fund?
JUSTIN THOMSON: This is a dynamic asset class with some great long-term growth opportunities. Don’t think tactically, think of it strategically, hold it for the long term.
PRESENTER: Justin Thomson, thank you.
JUSTIN THOMSON: Thank you.
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