Barings Europe Select: January 2023 fund update

• Lead fund manager Nick Williams boasts over 30 years’ industry experience, making him one of the most experienced investors in the European Smaller Companies sector
• The managers invest in small and medium sized European companies, which is different from most other European funds
• The fund has delivered higher returns than the average fund in the European Smaller Companies sector over the longer term, but has struggled more recently due to the rotation in investment styles
• The fund is on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

Barings Europe Select is different from many other European funds. The fund managers pride themselves on investing in small and medium sized companies with a GARP (Growth at a Reasonable Price) mindset. This means they’ll invest in those they believe can grow their earnings steadily, but whose shares can be bought at a lower price than the earnings potential suggests they should be. Most other European funds focus on larger, more established companies. The focus on small and medium-sized companies does increase the risk though.

We think the fund could be used to diversify the European element of an investment portfolio, or a broader global portfolio focused on growth.

Manager

Nicholas Williams is the Head of Small and Mid-Cap Equities at Barings. He’s built over three decades of experience investing in Europe and has managed funds investing in companies of all sizes. We believe this has given him superior knowledge of the wider European market over the length of his career.

Williams joined Barings in 2004 and took over management of the Europe Select fund shortly after. There aren’t many fund managers with such a long and successful track record of investing in this less familiar area of the European stock market. Williams is one of the few. He has demonstrated a long-standing commitment to his investment process and it’s a quality we rate highly.

Williams is supported by three co-managers - Colin Riddles, Rosie Simmonds, and William Cuss, who bring varying levels of experience to the table. He has a strong team of analysts to call upon too, alongside the research of other teams at Barings, including the Pan European and Global teams.

Process

Williams has followed the same investment process for many years – investing in companies he believes can grow their earnings steadily, but whose shares can be bought at a lower price than the earnings potential suggests they should be.

Williams instils this focus across his team. They scour the continent to identify smaller European companies they believe are in good financial shape, have low levels of debt, and are run by quality management. They’ll also only invest in a company if they believe its share price can rise by at least 40%. Companies should also be sufficiently liquid, meaning their shares should be relatively easy and quick to buy and sell.

The managers focus on the prospects of individual companies and invest in those they believe will do well regardless of what’s going on in the economy – their focus is ‘stock selection’. If a company’s shares hit their price target, the team will either sell some shares and take the profits, revise their price target if they think there is further room for growth, or sell it in order to move on to the next opportunity. If the share price falls by 20% the team will sell the investment.

We like the team’s disciplined investment approach, which has served investors well over the longer term. And we’ve seen the approach in practice over the last 12 months.

Several new companies were added to the fund, including Nexan, a French cable manufacturer, Puma, a footwear manufacturer and Verallia, a French glass packaging business.

The managers believe that Nexan is backed by a strong management team, who have a proven track record of executing their strategy. The company is also set to benefit from the energy transition efforts and heightened focus on cutting carbon emissions. The managers invested in Puma as they believe it boasts a strong franchise across the globe, is backed by a superior management team and is currently in a good financial position.

HelloFresh made a reappearance towards the back end of 2022. The team initially sold the company for a profit and decided there were better opportunities elsewhere. Since then, the company has streamlined their focus, pulling out of markets where they were struggling, and improved the state of their finances. The managers also felt it had dropped to a more attractive price, so have added it back into the fund.

A number of investments have also been sold, including hearing aid retailer GN Store Nord. Its recent product launches have been disappointing, and their recent acquisition faced criticism and weak demand. Rexel was another name the managers decided to sell. They took profits following the company’s strong run and have recycled the profits elsewhere.

While the managers don’t currently invest in them, investors should be aware they have the flexibility to use derivatives (borrowing to invest), which can magnify any gains or losses and increases risk.

Culture

We view Williams as the key manager behind this fund, and currently most of our conviction lies with him. But we are satisfied by the fact he's built a robust and collaborative team around him. All team members follow the same process, and they're encouraged to bring challenge and debate to each other's investment ideas, which we think is important.

The team are also influential throughout Barings, among other analysts and portfolio managers, which reflects their strength and fund management abilities. Williams also co-manages a few other funds at Barings, but we are comfortable his focus is on European equities.

ESG integration

Barings believes that incorporating environmental, governance and social (ESG) factors into their analysis provides a more thorough understanding of the complex issues, risks and value drivers that may impact their portfolios over time. All Barings fund managers therefore incorporate ESG criteria into their investment processes, with the aim to improve risk-adjusted returns. They use an ‘ESG assessment’ to identify improving or deteriorating ESG standards, and this can impact both the qualitative assessment of the company and its valuation forecast.

The firm uses its voting rights wherever possible and has engaged ISS (Institutional Shareholder Services) to provide voting recommendations, although fund managers can override any ISS recommendations if they see fit. The firm releases a voting record monthly, although no voting rationale is provided. Managers aim to meet with all the companies they invest in at least annually. During these interactions they discuss a range of topics including ESG issues. The managers also monitor companies and assess their ESG issues on an ongoing basis.

While Barings continues to develop its approach to ESG, the team has integrated ESG factors into their work for a number of years. They utilise nine key topics to help assess a company’s ESG impact, which could highlight businesses that use more sustainable practices and can thrive over the long term. This may help uncover risks that are less obvious through more traditional company analysis. They’ve also recently integrated another layer to their ESG analysis, carbon costs. This focuses on assessing a company’s carbon costs, their current emissions and decarbonisation commitments.

Cost

This fund is available at an annual ongoing fund charge of 0.81%, but we've secured HL clients an ongoing saving of 0.10%. This means you pay a net ongoing charge of 0.71% and makes the fund one of the lowest-cost actively managed funds available in the European Smaller Companies sector through HL.

The fund discount is achieved through a loyalty bonus, which could be subject to tax if held outside of an ISA or SIPP. The HL platform fee of up to 0.45% per year also applies.

Performance

Since Williams became the lead fund manager in January 2005, the fund has returned 605.54%* versus 442.81% for the average fund in the IA European Smaller Companies sector. Over the longer term this fund has tended to hold up better than the broader market when it's fallen. It hasn't kept up quite as quickly when the market has risen though.

More recently though, the fund hasn’t fared so well. The managers focus on investing in quality growth companies. These types of companies were hit hard by a sharp rotation away from growth investing, particularly early in 2022. Over the last 12 months, the fund has returned -19.21% versus -22.04% for the average fund in the IA European Smaller Companies sector.

The managers have struggled against a difficult market backdrop for smaller companies, and Europe as whole. That said, the fund remains ahead of peers, and marginally above their official benchmark. The managers have remained true to their investment process, so, the losses, while disappointing, are within our expectations.

Aside from the difficult market backdrop, there have been a number of stocks that have detracted from performance. SIG, a Swiss packaging machinery company, released mixed results. While revenues beat expectations, lower profitability, driven by recent acquisitions, hurt the company. GN Store Nord, a hearing aid manufacturer also took a hit over the last year, as recent product launches were not as successful as many hoped. Husqvarna, a manufacturer of outdoor power products and Getinge, a medical technology company, were also amongst the weakest performers.

In contrast, there were a few companies that delivered good returns over the past year. Dutch insurer ASR Nederland released strong results and was well positioned to deal with rising inflation. The Italian bank and online brokerage firm FinecoBank also held up well, as it benefited from stronger demand and growth in its earnings.

Past performance is not a guide to the future. Source: *Lipper IM to 31/12/2022.

Find out more about Barings Europe Select including charges

Barings Europe Select Key investor information