Isaac Chebar, manager of the DNCA European Select Equity Fund, explains why the ‘winner takes all’ model of market disruption is being overstated
WELCOME
Isaac Chebar presents the DNCA European Select Equity Fund, an actively managed, concentrated portfolio of European stocks unconstrained by sector, country or market capitalisation. The manager discusses the Fund’s contrarian bias, why he likes the pharma and energy sectors, and what the decline in bond yields has meant for value stocks.
These are harsh times for many long-established big box retailers. As they lose market share to newcomers, big retailers find themselves fighting for their futures, consigned to apparent irrelevance by the disruption of their sectors.
THE INTERVIEW
Challenging the market: the hunt for underrated winners in Europe
A contrarian view
The Amazon model is among the biggest threats. Now approaching a 50% market share of US online sales, the online giant is investing heavily to try to replicate that dominance in Europe. Meanwhile, agile new start-ups, unencumbered by legacy businesses, are making inroads too. In some cases, however, the markets may be too quick to write off the old guard. That is certainly the view of Isaac Chebar and his team of portfolio managers of the DCNA European Select Equity Fund at DNCA Investments, an affiliate of Natixis Investment Managers.
The fund has a contrarian bias. It is designed to seek out undervalued equities in continental Europe. But while challenging the market consensus on several fronts, he is candid about the current underperformance of value stocks. Across developed markets, these have been outpaced by growth stocks since 2009, barring a brief rebound in late 2016. One of the key reasons he highlights is the decline in bond yields brought about by the central banks’ easing of monetary policy. That has a disproportionate effect on companies with heavy capital investments and assets. Their challengers, meanwhile, effectively benefit from ‘free capital’ that helps them advance into their markets. “Established companies have responsibilities to deliver growth and dividends to their shareholders. But start-ups and the tech giants have the freedom to take market share without necessarily making a lot of profit,” Chebar points out.
While acknowledging these realities, however, he does not accept the received view of a “winner takes all” market that will see all traditional models swept away. “The market is not giving businesses the chance to transform,” he says. “Transformation is painful and takes time, but it can be done. But rather than allow for it, the market is selling out these businesses.” Some businesses and sectors will not survive disruption. But others will adapt: “I think some companies that are viewed as the big losers might be heavily mispriced by the market. “At the end of the day, some companies are able to transform themselves, because they still have legacy businesses generating serious cash which can be used to restructure and build a new business model.”
Time to transform
Looking to wider global trends, trade tariffs being imposed by the current US administration are not influencing his fund’s asset allocation in the short term. He believes that it’s too early to gauge how the US actions will play out – especially given the traditional Republican support for free trade. Where the US does occupy his mind is in the overperformance of its market compared to the rest of the world. In particular, the buoyancy of the US contrasts starkly with emerging markets, which have slumped considerably. Earnings in Europe, at around 8% to 9%, remained flat, he notes. “But in America, there have been upward revisions, and the fact that company buybacks are accelerating – we are at almost $800bn by the end of August – work as big support.”
Reading the economic signs
Areas where he believes the market view is too negative include energy, telecommunications and pharmaceuticals. Consumer brands, such as Unilever, Nestle and Reckitt Benckiser, may have to accept that their future digital growth is likely to be limited, he accepts, as AmazonBasics expands into supplying an ever wider range of products. However, these brands have the potential to hit back, says Chebar: for instance, investment in advertising could help them stay at the front of consumers’ minds in the face of challenges from newcomer brands.
DNCA European Select Equity Fund
Source: Natixis. As at 28 September 2018
The manager’s investment process
Isaac Chebar picks quality value stocks in Europe (ex-UK), without any capitalisation constraint, and this is facilitated by rigorous fundamental analysis. Stock selection is based on high quality quantitative research of listed companies’ financial statements (earnings, cash flows, balance sheets, etc.), company management and the economic environment. The manager aims to create outperformance over time through rigorous analysis, close scrutiny of volatility and a consistent investment process through different market environments.
Top 10 holdings
Asset allocation
FUND SNAPSHOT
Equity
Cash & cash equivalent
9.6%
90.4%
Country allocations
FUND Q&A
Well the fund is designed to outperform the MSCI Europe ex-UK index over the recommended investment term. We make the case for unloved companies and how, in the medium to long-term, we can make money by going against the market. In this respect the fund is a contrarian vehicle.
What is the DNCA European Select Equity Fund designed to do?
We start by asking: ‘where are the low valuations?’ Then we look at what the market is telling us about these low valuations and how we can interpret this differently. It may be the case that these low valuations give us an opportunity to invest. After this, we ask ourselves what the management has to offer. The fund takes a view of the company as a whole. ‘How much cash was generated over a period of seven to ten years?’ We look at how the company is evolving in terms of margin, its cash flow and results.
What is your investment process?
Telecommunications is something that hasn’t been working for the past two years, but we still believe there is operating leverage in the sector because we see a return in revenue growth and balance sheets are okay. So the commonalities are: low valuations plus they are unloved by the market. We are also keen on companies undergoing a restructure and sectors that in the future will be able to generate cash and pay dividends, but have so far gone unnoticed by the markets.
There are two or three risk areas we focus on. The first is corporate governance, especially when you are dealing with companies with a big minority shareholder or controlled by private partners. We need to know a little bit about the history of the company. For example: how does the family or the minority shareholder behave in a downturn? The second is financial risk. The fund invests at least 80% of its assets in shares of European companies, including Switzerland, but excluding the UK. Financial leverage is an important risk as companies with low leverage might not be obliged to sell assets on downturn at rock bottom prices and sound balance sheets can profit from distressed situations. The third is liquidity risk. A lot of liquidity in the market is trapped in exchange traded funds. And for the last 10 years the leading sector has been European small mid-caps. Money has been funnelled into that part of the market. So in terms of net flows, on the whole it has been positive just after the 2008 crisis until now. One never knows when a liquidity risk might emerge.
What key risk parameters do you identify and how are you mitigating them?
INVESTMENT OBJECTIVE To outperform the MSCI Europe ex-UK index over the recommended investment term RECOMMENDED INVESTMENT HORIZON Five years INVESTMENT UNIVERSE European Equity ex-UK REFERENCE INDEX MSCI Europe ex-UK LAUNCH DATE 12 May 2017 CURRENCIES AVAILABLE GBP
KEY FACTS
We’re very French these days, on the ex-UK side. We are buying pharmaceuticals which is something the market does not want because they’re suffering pressure from generics, biosimilars and more scrutiny from payers (governments or private payers). We have approximately 11% in pharma. And we still think energy is a place to be investing in in terms of dividends and buy backs. With regards to financials, we are underweight. Then in relation to telecommunications, we are overweight.
What is your level of exposure to certain investment themes/regions?
Well, we picked a lot of oil stocks in early 2016 when the market was really negative. We’ve been increasing our position in pharma over the last eight months because the team thinks the market is too negative about their future cash generation.
Are there value commonalities within the ESE Fund?
MANAGER BIO
Find out more at www.im.natixis.com/uk
Focus is an Incisive Works product. © 2018 Incisive Business Media (IP) Limited
For more information visit http://www.incisiveworks.com
This material has been provided for information purposes only to investment service providers or other professional clients, qualified or institutional investors and, when required by local regulation, only at their written request. This material must not be used with retail investors. An investment in such fund involves risk, including the possible loss of principal. Such Investment may not be suitable for all investors. Before determining if such investment is an appropriate investment, prospective investors must carefully consider the fund’s investment objectives, risk factors, charges and expense as described in the fund’s legal documentation. The provision of this material and/or reference to specific securities, sectors, or markets within this material does not constitute investment advice, or a recommendation or an offer to buy or to sell any security, or an offer of any regulated financial activity. Investors should consider the investment objectives, risks and expenses of any investment carefully before investing. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of DNCA Investments as of the date indicated. There can be no assurance that developments will transpire as may be forecasted in this material. Past performance information presented is not indicative of future performance. Although Natixis Investment Managers believes the information provided in this material to be reliable, including that from third party sources, it does not guarantee the accuracy, adequacy, or completeness of such information. This material may not be distributed, published, or reproduced, in whole or in part. Provided by Natixis Investment Managers UK Limited which is authorised and regulated by the UK Financial Conduct Authority (register no. 190258). Registered Office: Natixis Investment Managers UK Limited, One Carter Lane, London, EC4V 5ER.
Isaac Chebar, Manager, DNCA European Select Equity Fund
Isaac began his investment career in 1984. He joined DNCA in 2007 and has managed the DNCA European Select Equity Fund since 2017. He has a chemical engineering degree from the Polytechnic School of the University of Sao Paolo in Brazil.
