Fund Manager Briefing: Fidelity European Fund

Lipper’s Jake Moeller presents highlights of a presentation by Sam Morse, manager of the Fidelity European fund,  April 30 2014.

“Bull Markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”

REUTERS/Kai Pfaffenbach

Opening with this cautionary quote by Sir John Templeton, Mr. Morse, although not entirely bearish on the outlook for European equities, intimates that investors consider there will be a lukewarm—if not a cold—shower on the asset class.

Looking back at the market since May 2012, he notes that the best performing European companies have been either dependent on high leverage, based in peripheral Europe, or simply floating on the “rising tide” of momentum. He points out that, while European rerating has risen over 30% since March 2012, earnings contributions have actually been negative over the same period. In comparison, the U.S.A.—with a similar return—has had over 10% increase in contributions. Mr. Morse, with his considerable experience managing U.K. investment trusts, is also concerned that historically low discounts to NAV (now around 5%) are compelling evidence that the European market generally may be too euphoric.

It is clear that the recent market environment has not been conducive to Mr. Morse’s portfolio construction process. The Fidelity European Fund underperformed its benchmark by some 9 percentage points for 2013:

 Table 1. Performance Summary – Fidelity European Fund 

Source: Lipper, a Thomson Reuters company.

Mr. Morse is an ardent picker of dividend growth stocks, and it is the inherent quality bias in his portfolio that has detracted from its overall performance. For 2013 only 30% of his portfolio beat the market, with many consistent “dividend growers” such as Novo-Nordisk, Nestle, and Sanofi failing to keep pace.

To Mr. Morse’s credit he also accepts that there has been some adverse stock selection. For example, he defended Turkiye Garanti Bankasi, stating that Turkish banks are very well capitalised and are strictly regulated. He continues to prefer his largest active position, Nestle, over Unilever and Danone because of its strong product range, improvements in sales, margins, and a “refocusing” of the business on return on capital.

Far from being a harbinger of doom, Mr. Morse’s message is delivered with balance. He suggests European valuations are expensive but not historically so (the 12-month forward median P/E of the  FTSE Eurofirst 300 Pan Europe index is currently 15.5x and has been considerably higher than its long-term average of 14x). He also recognises that macro considerations may yet drive the exuberance further. But, with a portfolio well diversified across the capitalisation spectrum, he is happy to await a rotation back to quality.

Since taking over the fund from Tim McCarron in December 2009, Mr. Morse has had three strong years and—despite a poor 2013—still remains in the second quartile:

Table 2. Performance of Fidelity European Fund within IMA Classification.

Source: Lipper, a Thomson Reuters company.

Sam Morse has a considerable pedigree in dividend investing and despite the recent bout of under-performance is totally confident that market conditions will again turn in favour of his style. His overall track record suggests he may well be right and that a lukewarm shower on Europe is forthcoming.