by Jake Moeller.
Lipper’s Jake Moeller reviews highlights of a presentation by Mike Clements, fund manager of OYSTER European Selection Fund, on October 13, 2014, and January 5, 2015.
Mike Clements’ recent move to Syz represents a clear intention for Syz to flex its muscle in the European equities sector. More widely known for his stint at Franklin Templeton at the helm of the successful (and now soft closed) Franklin European Growth Fund, he has brought along his former colleagues, including Claire Manson, and has been joined most recently by Alasdair Cummings—to form a compact but experienced team.
The transition from a large house to a smaller boutique can pose some challenges for fund managers; however, most find the change liberating, since they face less corporate bureaucracy and committee-based distractions. This is certainly the case with Mr. Clements, who appears to be relishing the opportunity to build his own franchise with the Swiss-based private bank. He comes armed with his intellectual capital and imports his already-established contrarian stock-picking style and a very respectable track record straight into the fledgling Syz equities suite.
OYSTER European Selection Fund is a high-conviction multi-cap fund and a highly concentrated pan-European fund consisting usually of between 30-40 stock ideas. Thus, it is suitable for investors who seek a high level of active share in their portfolio. However, Mr. Clements is not an advocate of high turnover. One of the key aspects of the portfolio is the forensic analysis that underpins the ultimate inclusion of a stock. His emphasis on the potential downside risk to a company means the lead time before a stock ultimately appears in the portfolio can be considerable. “Risk is a simple concept,” Mr. Clements says. “It’s not a statistical measurement like volatility but rather a risk to a business. Can the Chinese enter the market and take share away from my European industrial company? What happens if there is a price war?” Such constant questioning results in low portfolio turnover of 30%-50%, with potential three- to five-year holding periods.
Mr. Clements seeks high-quality companies with a strong balance sheet and a competitive advantage that are under short-term pressure or longer-term recovery plays. This might include businesses with temporarily weak earnings linked to an adverse business cycle (Nokian Tyres—a leading producer of winter tires, with about a third of its profit coming from Russia) or firms experiencing a realignment of their business model (DIY retailer Kingfisher, which owns Castorama in France and B&Q in the U.K. and is both a play on long-term recovery in French construction and operational improvements in B&Q).
Table 1. Percentage Growth of Mike Clements Composite* from 30/9/2010 to 26/1/2015 Vs Lipper Global Equity Europe Classification.
To reduce his investible universe of some 3,500 European stocks he employs a number of screens. For example, he might consider only companies with a return on equity over the last five years of 15% pa or greater on average but trading on a free-cash-flow yield of 10% pa. Where this might return only 100 candidates, he will then demand more in-depth analysis. He augments his idea generation by attending industry conferences, management meetings and undertaking supply-chain analysis. He also gives his team of five analysts considerable freedom to bring their own ideas to the portfolio understanding, broadly what Mr. Clements “likes and wants to pay.” Stocks then go through a thorough examination of cash flow and financial statements and are set a valuation using a DCF model with a conservative discount rate of 10%. Finally, team debate on a stock is undertaken, with the intention of “killing the idea,” and if it survives, it goes into the portfolio.
Mr. Clement’s process results in his portfolio having biases to the consumer discretionary, industrials, and financials sectors (mainly asset management and consumer credit). He eschews banks because of opaque balance sheets, telcos where he struggles to understand the business models, and utilities because of regulation and leverage. The resultant portfolio has an “unintentionally defensive” bias and a portfolio beta typically below one.
Table 2. Risk Return Chart of Mike Clements Composite* from 30/9/2010 to 26/1/2015 within Lipper Global Equity Europe Classification.
Mr. Clements doesn’t dwell too much on lost opportunities or underperformers. Reflected perhaps by his longer-term track record being ensconced safely in the north-west quadrant. “Of every 10 stocks, 6 will make me money. It’s okay if we make a bad call. The key is to exit a position that goes bad quickly and I reward my team facilitating this.” He cites Halfords as a recent example. “It was a good business,” he says, “it had a 3rd of the market for bikes, a 10% FCF and was trading at £3.50” After disclosures on profit drivers and the realization that Internet erosion was higher than expected, Mr. Clements sold quickly, losing a third of his investment but finding a better opportunity as Halford’s fortunes tumbled further.
Mr. Clements believes it is still a good time to invest in Europe but that valuations require fund managers to be more discerning. He is encouraged by the actions of European CIOs, noting the increases in capex and M&A activity. He is finding ideas in Russia, in cyclical parts of the market including energy services, as well as in construction and housing plays. However, he does urge some caution: “Since October 2014 both the Russian situation and the oil price have deteriorated and so we are still assessing various stocks in these sectors but the most interesting places to hunt are those areas out of favour.”
* The Composite has been created in Lipper for Investment Management by taking the performance track record of Franklin European Growth Fund from when Mr Clements assumed the role as its lead portfolio manager on September 30, 2010 until his departure interposed on the performance of the OYSTER European Select Fund from his start date at Syz on September 15, 2014.
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