Fund Spotlight: a unique approach to value investing

As we enter a new year, one as yet unmarked by the dominance of the Magnificent Seven – the seven largest technology names in the US stock market – Europe emerges as an alternative to the elevated valuation levels seen across the Atlantic.

EdenTree views Europe as a value market, offering access to a diverse array of domestic and multinational companies at historic valuation discounts compared to the US market. The undervaluation of these markets also presents an opening for investors to find hidden growth opportunities in companies that will benefit from the transition to a more sustainable world and benefit from strong structural growth trends. Europe is a world leader in sustainability, offering investment opportunities into some of the most innovative sustainable products and solutions.

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EdenTree Responsible & Sustainable Europe Equity fund seeks out companies that are currently facing challenges or temporary setbacks, but have a promising outlook for recovery. The fund aims to achieve long-term capital growth with a focus on income generation, by investing in a highly diversified portfolio of sustainable companies.

The £165 million fund has been led by Chris Hiorns since 2007. Having joined EdenTree as a graduate in 1996, Hiorns has an impressive track record of outperforming both the index and peers since taking over management of the fund. Hiorns utilises expertise from co-managers David Osfield and Tommy Kristoffersen, as well as the wider five-strong responsible investment team at the firm. However, all investment decisions are made solely by Hiorns.

The recent reshuffle of the responsible investment team saw Carlota Esguevillas appointed as the new head, and Will Oulton named the new chair of the investment advisory panel, bringing valuable knowledge and deep expertise to monitor and support EdenTree's responsible investment strategies.

The investment process begins with negative screening, excluding stocks such as tobacco, gambling and fossil fuels, and then screens based on financial ratios, including cash flow and dividend yields. The team then applies a positive ESG screen (environmental, social and governance factors) to stock picking to assess a company’s overall contribution to current themes of education, health and well-being, social infrastructure, and sustainable solutions. This positive screening is not a pre-requisite for entry into the fund, but any solid tailwinds for a theme make for a good investment case.

What does the fund invest in?

The portfolio comprises 50 to 70 holdings (currently 51) with individual stock weightings kept within 1% to 3% to enhance diversification and mitigate risk. However, weightings can drift up to 5% following periods of good performance.

The portfolio has a strong mid-cap and value bias, distinguishing it from peers in the sustainable investment universe that tend to exhibit a growth bias. The fund has historically demonstrated success with this contrarian approach, which diverges notably from its benchmark. This was evidenced for example by the timely shift to be overweight in banks in Q4 2020, a move that significantly benefited the fund’s performance until the end of 2022.

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Hiorns seeks companies that are more cyclical in nature, meaning that they may perform better in periods of economic strength but can underperform in times of downturn. Analysis of the strength of companies’ cash flow helps the team distinguish between businesses out of favour due to temporary challenges and those facing more long-term issues. This means investments are regularly reviewed to ensure the fund is not holding any value traps and the companies are on track to recover.

The approach has led to a current overweight versus the index to financial services (+6.3%), communication services (+6.6%) and real estate (+3.8%) and the largest country allocations are France (31%), Germany (18%) and the Netherlands (14%).

Currently, only one holding is above the previously noted weighting limit of 3%, Rexel SA (EURONEXT:RXL) with a weight of 3.2%. This is a French electrical distribution company that also distributes renewable energy and energy efficiency solutions. It returned 34.3% in 2023. Another high conviction holding is Banco Bilbao Vizcaya Argentaria SA (XMAD:BBVA), a Spanish multinational bank, with a portfolio weight of 2.9%.

How has the fund performed?

The fund returned 7.1% over the past year, with mild underperformance compared to the benchmark (-1.7%). This was in part a product of the fund’s zero weighting to energy companies and the underweight (holding less than the index) to large-caps, growth companies, which bolstered the index throughout 2023. However, over three years, the fund succeeds in beating the benchmark, returning an annualised 10% versus 9% for the index, benefiting from its overweight to the financial and industrial sectors. 

The fund demonstrated its ability to navigate volatile conditions and wider market drawdowns throughout 2022. While the fund returned an almost flat 0.1%, this proved resilient versus its more growth-heavy benchmark and peers which drew down -7.0% and -8.7%, respectively. The biggest contributor to this relative outperformance was the aforementioned overweight to financials versus the benchmark (+5.4%), which included exceptional returns from the Bank of Ireland Group (EURONEXT:BIRG) of 86.4% in the year.

Source: Morningstar Direct Total Return (GBP) as at 31/01/24.  Past performance is not a guide to future performance.

Why do we recommend this fund?

The fund’s patient and diversified approach to investing, evidenced through the manger’s ability to protect downside in times of market downturn and allowing investments the time to perform, has proven successful. Despite facing challenges in the past year, its track record of outperforming its benchmark and peers over a three-year period underscores its resilience and potential for delivering favourable returns.

This is a unique strategy among its peers in offering investors a value-focused approach to accessing long-term structural growth trends in some of the world’s leading sustainable companies. The contrarian view means the manager does not follow the hype but applies a rigorous bottom up stock-picking process to avoid excessive valuations relative to fundamentals, while adhering to the firm’s responsible investment principles.

With a yearly ongoing charge of 0.81% and an average dividend yield of 4.7%, this fund is a solid European addition to balance out a growth-biased portfolio. As such, the fund is a new inclusion on our ACE 40 list as an adventurous European offering.

Please find the latest factsheet here.