Threadneedle: Asian investors shouldn't write off Europe

Dan Ison joined Threadneedle in 2007 as head of pan-European equities and manages the Threadneedle Pan European Accelerando Fund and the Threadneedle Pan European Sicav. Before joining Threadneedle he was a partner at Clareville Capital.

He started his career with Baring Asset Management in 1994 as a fund manager and moved to Beaumont Capital/Schroders in 2001 as a partner/director.

The Pan European Accelerando Fund gained 35.8% in 2009 (against the benchmark MSCI Europe 32.55%) and is up 6.66% YTD this year (benchmark is 4.21%). The Threadneedle Pan European Sicav was up by 31.8% in 2009 (against a benchmark MSCI Europe 33.15%) and is up 6.43% YTD (benchmark 6.37%).

Threadneedle embarked on a push to increase distribution in Asia earlier this year. What flows are you seeing from Asia into your European equity funds?
We took a big step when we acquired Standard Chartered's Sicav business on July 1 last year. Our previous focus as a firm had been outside of Asia, in particular in Europe, and our sales in Asia across all funds were small. We took on 32 Sicav funds, including four European funds.

We've done some restructuring, including replacement of third-party managers and some fund consolidation, including in European equity. We now have a more focused offering from Threadneedle on this platform, which will form an important part of our development in Asia. Of the $2.4 billion we manage in the Sicav structure, around one-third is sourced from Asia.

We're not seeing much in the way of flows from Asia at present into European equity; the level of interest is low -- understandably. In any case, most flows we see are from local markets in Europe.

Another growth market for us has been the Middle East; we've taken on board roughly 50% more AUM from Middle East in the past 18 months -- we're talking in the hundreds of millions of dollars.

Now the proportion of AUM sourced from that region is in the teens [in terms of percentages]; it's growing faster than our local markets.  We've seen a lot of flow into equities and bond products, particularly corporate bonds, in the past 18 months. Absolute-return funds have seen very strong inflows in the past year. Obviously we hope that our new business in Asia will attract the same success as the Middle East.

Presumably European and UK instruments have been less popular recently, due to sovereign debt concerns over Greece, Portugal and so on?
As regards European and UK equities, that's not been area where we've seen huge flows, but then that's probably true of the equity market as a whole. There's not been a return to equities from our traditional European client base, who are still underweight equities, with a lot of money sitting in cash. Insurers and pension funds still have a long way to go [in terms of increasing their equity allocations].

One way I often look at equities is to consider the risk premium you pay to hold equities over bonds. It's probably averaged about 3% historically, but now is around 5% or 6%. There's been a huge bull market in bonds in the past year or so, but not [to the same degree] in equities. 

How are the sovereign-debt issues affecting investment from Asia specifically?
[There's a] negative tone in Asia as regards investment in Europe at present. However, while clearly there are some issues with sovereigns in peripheral markets, there are plenty of opportunities for active stock-pickers to make money within European equities. You shouldn't ignore Europe because one of the smallest nations has blown up.

Of course, there are currency issues [over the euro], but a weaker currency should actually benefit economies and companies in Europe. There have been very few prolonged periods of euro weakness, so companies may now benefit from a prolonged period of weakness for the currency. Especially since despite having a strong currency for a long time, Europe has developed a strong, lean and mean corporate sector.

[In Europe,] balance sheets are extremely strong. Two rounds of restructuring in 2001/2002 and 2008/2009 may mean a number of European corporates will achieve margins in 2010 or 2011 that they last saw in 2007, despite sales being well down on a few years ago. As a result, it's wrong to write off Europe as an investment backwater now.

But presumably there will always be a relatively small amount of Asian investment into your European equity funds?
Longer term, there's an enormous amount of wealth creation occurring. As Asian markets such as China mature, investors look to become more sophisticated, and the more that happens, the more they look to diversify away from their home markets. So we see as long-term opportunity, by making sure we're present on a local scale and able to offer all types of products [with underlyings from across the globe].

We're certainly looking to grow our Asia team [which is based in London] by the end of the year, although we don't have any plans to relocate Asia-focused investment professionals away from London.

Are price-to-earnings and price-to-book ratios low, high or about right for European equities?
We have European earnings growing by at least 20% this year, with low forecast inflation. There are extremely strong [corporate] fundamentals at a micro level, particularly when you exclude financials. We envisage very strong performances from companies, particularly in terms of return on capital and so on.

There were some genuine bargains around 12 months ago -- for example, Nestle was at around 10x P/E, for a company that's consistently able to grow at 6% or 7% a year. Those sort of levels presented very interesting opportunities. Nestle is now at around 16x P/E, and is [still] growing organically in the high single digits, it has very strong cash flow characteristics, can borrow money at lot cheaper than some countries.

This situation for some corporates reflects a consensus view that earnings have a long way to go; perhaps a 20% rise this year and for 2011 and possibly 2012 high single-digit growth.

You have a number of investment themes around European equities -- which of them are of particular interest to Asian investors?
From a European perspective, we look strongly at China. Probably one of the biggest issues for us is to investigate the competition situation vis a vis china and rest of world. That's part of reason I'm here to spend time in China, to look at European subsidiaries based there.

Therefore, one of our investment themes -- being long of what china is short of -- is an important one. What can Europe provide that China doesn't have? This relates to strong [manufacturing] competition coming out of China.

For example, the telecoms equipment market has changed very fast in the past 10 years -- [companies like [handset makers] ZTE and Huawei are aggressively taking share from traditional European players like Nokia, Siemens and to an extent Sony Ericsson. This has happened very quickly; it's a phenomenon of the five or six years just gone. There is the issue of emerging Chinese competition in these areas that we have to be aware of.

[We also] need to be aware of business in Europe that can't be replicated by China. For instance, they can't replicate Rolls Royce or Louis Vuitton goods -- they may be able to make similar items, but will never be able to do the real thing.

Never? Really?
Luxury goods makers [such as those mentioned] will never make those luxury goods in China, and so those goods will never have the cache of, say, Italian or Swiss goods. It is the very fact that Swiss watches are made in Switzerland using Swiss engineering that gives the brand its cache.

How about other areas, such as commodities?
Yes, there is the obvious resource trade -- China being short of oil, metals and so on. In the listed UK market we have many such stocks, such as [mining companies] Rio Tinto, BHP Billiton and Xstrata.

Also, the pharmaceuticals sector is strong in the UK. We haven't seen strong companies in that sector coming out of Asia.