Threadneedle's AAA-rated Heslop eyes 'painful' correction for equities

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Threadneedle Pan European Smaller Companies manager Mark Heslop thinks equities markets are due a significant pull back which would have ‘painful’ repercussions for investors.

Heslop, who also took the reins of the €1.6 billion Threadneedle European Smaller Companies fund from Dave Dudding at the start of the year, thinks the market is unlikely to be significantly higher in 12 months’ time but that small caps will continue to offer the best chance to add alpha in difficult markets. 

He told Citywire Global: ‘We could see the market continue to go up but it will be rocky with the fiscal cliff, and Italian and German elections to factor in so we expect a fairly sizeable pull back which will could be quite painful.'

‘I would not bet on the market being higher in 12 months’ time but there will still be opportunities. Our process means we look at where a company will be in five years’ time. Smaller companies present a much larger opportunity than large caps because they are much less covered by analysts and offer more opportunities to generate alpha.’

Equities still historically cheap

Overall the Euro Stars AAA–rated manager is cautiously optimistic because he believes equity prices look attractive on a historical basis. However he adds that equities should look cheap, considering the years of low growth ahead for much of Europe.

‘The market as a whole should continue to rise and the positive flows into equities will be a key driver.’

Heslop has been adding selective stocks to the portfolio from the European autos and luxury goods sector which he believes are too cheap to ignore.

A position in Swedish safety belt and airbags specialist Autoliv was bought in January as Heslop eyed the company’s expansion into emerging markets while he has also been adding to Dutch cable firm Ziggo in recent weeks on market weakness.

He said: ‘European autos have been attractively valued for some time. We see good value in this sub sector, but we want to own the companies with the best pricing power and strength of the business model is absolutely crucial.

‘Autoliv is benefiting from significant growth into emerging markets and from the tighter safety standards being adopted globally as well as the improving road infrastructure which allows cars to go faster.’

Elsewhere Heslop has been rotating some of his holdings in the luxury goods sector, selling out of high end Italian cashmere producer Brunello Cucinelli after a strong market run and initiating a position in fashion brand Ferragamo, which he thinks is on a far more attractive valuation.

Testing company Bureau Veritas has also been sold down after a strong run but remains a core position within both the Sicav and the Oeic.

Heslop took on the €1.4 billion Threadneedle European Smaller Companies fund from AAA-rated colleague Dave Dudding at the start of the year but has worked closely with Dudding and European equities head Phil Dicken for the last five years.

In keeping with the European equities team’s investment approach Heslop focuses on companies with high recurring revenue business models that can generate high returns over and above their cost of capital over time.

His Threadneedle European Smaller Companies has about 70% commonality with the UK fund with most of the stocks that differ being due to the latter index’s large UK weighting.

While his investment style is very similar to Dudding’s, he says one differentiator might be his willingness to sell down positions a little more quickly once they reach their price target and he anticipates adding a few more holdings to the 73 stock portfolio.

‘Our approach is the same in that we both like the pricing power model and while there may be no change in investment style, the only difference may be on valuations.  I am more likely to trim things that have got too expensive in the short term.’

Heslop will buy up to a 2% position in a stock and will sell it if it moves above 3% of the portfolio to spread the risk on what can be a volatile asset class.

‘Small caps are potentially a higher risk asset class so we like to have diversity across the fund.’

‘I am possibly a bit more analytical while Dave is a great reader of business strategy and business models.

Heslop is also maintaining the longstanding fund overweight to industrials and healthcare while continuing to avoid most financials.

‘Industrials and medical technology often tend to be among the global winners with their focus on individual niches. We don’t expect to find global winners among mid and small cap banks.’

Over five years to the end of January the Threadneedle Lux Pan European Smaller Companies fund has returned 72.5% compared to the benchmark MSCI Europe Small Cap TR EUR return of 43.5%.