Europe’s answer to the Magnificent Seven – at cheaper prices

Fidelity European fund manager Marcel Stötzel sits down with Sam Benstead to discuss the opportunities from investing in Europe.  

He speaks about the “GRANOLA” shares, which he says are Europe’s answer to America’s Magnificent Seven, but come with lower valuations for similar earnings growth. 

Stötzel also talks about why he keeps cash levels low, doesn’t try to time the market, and what the differences are between his open-ended fund and investment trust.  

Fidelity European is a member of ii’s Super 60 list of recommended funds.  

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Sam Benstead, deputy collectives editor, interactive investor:Hello and welcome to the latest Insider Interview. Our guest today is Marcel Stötzel, manager of the Fidelity European fund. Marcel, thank you very much for coming in.

Marcel Stötzel, manager of the Fidelity European fund: Thanks for having me, Sam. Great to be here.

Sam Benstead: You're investing in European shares, not UK shares. Something you’ve said before is that European shares don’t mean you’re investing in the European economy. What did you mean by that?

Marcel Stötzel: I think it’s a very important point and this is a stat that often surprises people. Only one-third of MSCI Europe's revenues come from Europe, which obviously means two-thirds of the index’s revenues come from outside Europe.

A place like the US, for example, is around 25% of MSCI Europe's revenues. The US is almost equally important to European companies as their home region of Europe, which I think a lot of people wouldn’t think of off the top of their heads. To be honest, Europe is quite unique globally in terms of having that much more abroad versus domestic mix.

Sam Benstead: That must be a positive for the fund then. If Europe goes through a recession, earnings might be protected.

Marcel Stötzel: Exactly. If we look over the long term, here’s another interesting stat. If I look at the 30-year history of the trust, for example, if I look at MSCI Europe versus the world over that period, the MSCI Europe has held up and been pretty much in line with the MSCI World.

If you think about everything that's happened over that period. If I asked you to tell me what has happened to Europe over the last 30 years, you probably have a number of negative things to say. For example, Brexit, Grexit, the eurozone crisis, the migrant crisis.

If I asked you what’s happened to the world over the last 30 years, you’d probably have a lot of positive things to say. You’d say that the US has been great, China has emerged, India has emerged, but humble Europe has kept pace with that.

I think the reason for that is because European companies have benefited from the rise of China, from the rise of India, from the continued rise of the US, almost as much as those domestic companies have.

Sam Benstead: And why should investors own a Europe fund, having a dedicated manager pick shares there?

Marcel Stötzel: It’s really the valuation differences. If you believe, as I said, that European companies are global just like any other, then the valuation differences, particularly between the US and European companies, starts to become quite stark.

You can look at equivalents, Boeing versus Airbus or Estee Lauder versus L'Oréal, or even just more as a general theme. Europe is not a graveyard index, but even more than that, Europe is a very nice stock picking index. It doesn’t have the high concentration the US has. There are a number of really good managers. Governance is typically very good in Europe, sometimes even better than in the US. There are pockets of fantastic companies that you can often get at a discount if they were listed in the US.

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Sam Benstead: Can we put some figures on the valuation gap with the US? Relatively, how much cheaper is it to own European companies versus similar American ones?

Marcel Stötzel: It's a very hard question to answer because you need to adjust for difference in sector allocation. So, European companies are less tech heavy, less growth heavy, which is obviously in favour right now. So, it’s a tough question to put exact numbers on. An example might be, the ‘GRANOLAS’, which [is a term] Goldman Sachs came up with.

I’m not a massive fan of that nickname, and it’s a bit of a hodgepodge of companies. But nonetheless, if you compare the GRANOLAS to the Magnificent Seven, they’re trading at a similar level of growth.

I can't remember off the top of my head, but 4 or 5 times less price-to-earnings (P/E) multiples than the Magnificent Seven. And while it’s not my favourite acronym, I think it does highlight the valuation differential when you try and do it on a like-for-like basis.

Sam Benstead: And these leading European companies, the GRANOLAS. How many of those do you own? And can you explain why they are genuine world leaders?

Marcel Stötzel: We own roughly around half. ASML Holding NV (EURONEXT:ASML), Novo Nordisk A/S ADR (NYSE:NVO), Lvmh Moet Hennessy Louis Vuitton SE (EURONEXT:MC), SAP SE (XETRA:SAP), so we are in roughly half of them. The common thread between all of them is that they are businesses that can stand on their own two feet, really compete head-to-head on a global stage with whoever the competitors are and really win.

ASML has no competition. They're head and shoulders above the rest. LVMH, it's head and shoulders above any kind of other luxury goods company besides perhaps Hermes International SA (EURONEXT:RMS), which is also European. So, I think that’s what we feel is the key to a number of European stocks. If you can find them, they can really go head-to-head and win versus any global pier.

Sam Benstead: Compared to the UK, what types of sectors and companies are you getting in a Europe fund versus a similarly managed UK fund perhaps?

Marcel Stötzel: The main difference is the sector breakdown, so the UK tends to be a lot more natural resources, a lot more banks heavy. Whereas if you look at Europe, it tends to be more tech heavy, more industrials heavy, more luxury goods, more autos. So, just those sectoral difference. The UK tends to, for that reason, be much more of a value-type index. And Europe tends to be more of a growth index, not as much as the US obviously, but along that continuum.

Sam Benstead: And you manage an investment trust as well, Fidelity European Trust Ord (LSE:FEV). Is that managed in the same way? How is that different? What would you say about [whether] you should invest in the trust or the fund, what are the differences there?

Marcel Stötzel: The difference is the trust has gearing. We gear up 115%. And the reason we do that is we believe that markets over time will rise. And we want investors to get the benefit of that gearing and to get that additional kind of kicker, if I can call it that, [over] time.

The second difference is that we can short shares in the trust. So, we do have some short positions from time to time. We have one right now. Other than that, on a name basis, they’re identical. It’s just a question of whether you want slightly more risk for potentially more reward in terms of higher gearing and the ability to short, in which case you would go for the trust. If you want the core defensive nature that I mentioned earlier, then you would probably go for the open-ended vehicle.

Sam Benstead: And that short position. I've got to ask, what is it?

Marcel Stötzel: Unfortunately, we cannot disclose short positions, but it’s an industrial company.

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Sam Benstead: You don’t hold any cash in the portfolio. Why is that?

Marcel Stötzel: We don’t want to have a material cash drag. It doesn’t sound like a lot, but if markets over the long term are going up 10% per year, who knows if that will continue, but just to [offer an] example, if you hold 2-3% in cash, that’s a 20 to 30 basis-point drag that you’re getting year after year after year after year.

Some people are smart enough to time it and then raise the cash allocation and then lower the cash allocation to time the market. We are an order of magnitude, [and] not smart enough to do that. We stick to what we think we’re good at, which is stock picking, and leave timing the market and playing around with the cash to other people.

Sam Benstead: You’re a stock picker, but is there anything happening in the macroeconomic environment which is creating an opportunity now as a stock picker?

Marcel Stötzel: It’s a bit of a tough environment for opportunities right now. I’d say we’re a bit cautious. There are some things that are making us more cautious and we’re trying to dial down more on rather than looking at the other side, for example, [when a] soft landing was the base case.

One thing that we are adjusting on the cautious side is leverage. If you think of what's happened, if you cast yourself back, imagine you are a chief financial officer in 2020 during the depths of Covid. The world is falling apart. Interest rates are at zero. What would you do? You would fill your boots with as much fixed-rate debt as you could get your hands on. If you need it, great. You have it. If you don’t need it, you could just pay it back.

A lot of that fixed-rate debt, just like somebody with a home with a mortgage that’s fixed, hasn’t really [felt] the impact of higher interest rates. It will typically roll off the back end of this year into early next year because you’ll typically be four-to-five years fixed. What that means is, from a macro point of view, but more importantly for us as stock pickers, companies with high leverage might be in for a bit of a shock.

Even if it’s a utility that’s not going to go bankrupt, we think investors in the market might be shocked when suddenly, in a year’s time, you get a big jump in that interest income and interest expense line. So, we’ve been dialling back companies with high leverage over the last few months.

Sam Benstead: And finally, the question we ask all our guests, do you personally invest in your portfolio?

Marcel Stötzel: I don’t for the simple reason of diversification. If I look at my personal balance sheet, all my long-term earnings as well as short-term earnings are heavily tied to this fund already.

So, in the same way as in my personal investments, I don’t invest at all in Europe. All my personal investments outside this fund are in Europe, in the US, Asia or outside, to try and diversify away in the same way that we would do if we, for whatever reason, had big Germany overweight or big industrials overweight, we would try and manage that. I try to use my non-fund exposure to manage that diversification too.

Sam Benstead: Marcel, thanks very much. It's been great talking to you.

Marcel Stötzel: Thanks a lot for having me, Sam. Much appreciated.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel, where you can like, comment, and subscribe. See you next time!