It is hard to be particularly bullish on markets at the moment. The daily headlines make for gloomy reading – a devastating and protracted war in Ukraine, soaring energy and commodity prices, hawkish central banks and a cost of living crisis. Furthermore, a sharp rotation from growth to value this year has caught many investors off-guard, leading to a very wide range of returns. Investor reflection and soul-searching after such a difficult first quarter has prompted a series of difficult questions:
- Do you still buy the dip or will equities follow the savage sell off in bonds?
- Is now the time to double-down on the growth style which has outperformed for so long or are its best days numbered?
- Is investing in value sectors such as energy and mining compatible with ESG?
- Has value become a crowded trade and how will it fare in a stagflationary/recessionary environment?
We don’t pretend to have the answers to these complex questions and we are wary of anyone claiming to know what the future holds with any real conviction. These are some of the trickiest markets we have faced in our careers - a view likely shared by many other investors. With geopolitical concerns coming to the fore at the same time that central banks are tightening liquidity, markets will likely stay volatile for the foreseeable future.
Amidst all the doom and gloom, there are some glimmers of hope. While we are the first to acknowledge our limitations when it comes to predicting macroeconomics (and now geopolitics!), as stock pickers we embrace rapidly changing and volatile markets as it allows us to uncover new and often overlooked opportunities. Market volatility often leads to a much wider dispersion of stock returns which is good for active management and stock pickers. Is a broad, passive investment in Europe advisable right now given the headwinds? Perhaps not, but we believe there are certain stocks and parts of the European market that are very interesting. Our highly active, all-cap approach allows us to the position the fund to benefit from these opportunities.
For example, we believe one of the main long-term outcomes from the Ukraine conflict is a renewed and immediate focus on energy dependency in Europe and a reduced reliance on Russian oil and gas. This pivot away from Russia has taken on a new sense of urgency with Poland and Bulgaria being cut off and Putin threatening to turn the taps off completely if payments aren’t made in roubles. Germany is at particular risk, given its reliance on Russian gas and talk of a full-scale embargo is spreading panic through the industrial heartland of Europe. Indeed, the CEO of chemicals group BASF suggested any shutdown could plunge German business into its “worst crisis since the second world war”. Governments are responding to this crisis at speed. The European Commission plans to cut Russian gas imports by two-thirds this year, as part of a package to diversify gas supplies and accelerate decarbonisation efforts. This will require enormous investments in infrastructure, new sources of liquefied natural gas (LNG) and accelerating the build out of renewables.
When supply chains get redrawn on such a huge scale, there are beneficiaries and our ability to move down the market cap spectrum allows us to identify and invest in those winners. For example, Friedrich Vorwerk is a small-cap German company that is relatively unknown, but will play a key role in Germany weaning itself off Russian energy. With decades of experience, Vorwerk is a leading player in the design and implementation of critical energy infrastructure in natural gas, electricity and hydrogen. Utility and energy customers are now urgently turning to them, and Vorwerk’s biggest challenge is ramping up in advance of the massive influx of orders that it could win in coming months. There are other under-the-radar opportunities like this. Exmar is a small Belgian company that owns floating LNG infrastructure that could help European energy companies quickly realign some its gas supplies away from Russia in time for the winter.
Europe is changing fast. The energy transition was already underway with Europe leading the world with its green agenda. However, this voluntary and measured transition has now been escalated to an urgent case of energy security. The threat of energy rationing in Germany this winter is real, and governments and corporates are responding with a massive wave of investment. Amidst all the top-down noise and geopolitical newsflow occupying the market, we remain focused on hunting up and down value chains and finding (often contrarian) ideas that are set to benefit over the long term from a changing Europe.
Pras Jeyanandhan & Mike Clements
Managers, VT Downing European Unconstrained Income Fund
Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein.
Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term and are higher risk compared to investments solely in larger, more established companies.
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