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Outlook 2021: Niall Gallagher


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12 January 2021

Niall Gallagher takes a look at some of the European equity themes that were ’supercharged’ over the course of 2020, discusses the importance of a focus on ESG and explains why he is optimistic on opportunities in the region this year.

What worked well in European equities in 2020?

The key to 2020 was being flexible. The year changed shape probably two or three times as it went on. We began the year reasonably optimistic about the European economies, the US and China, and in a relatively pro-cyclical portfolio expression. We then obviously had the emergence of the coronavirus, beginning in China then spreading westwards. On top of that we had some pretty severe turbulence in financial markets which necessitated some changes. What became clear was that many of the long structural trends we had exposure to really began to exert themselves as markets began to recover; those stocks exposed to consumption growth in Asia and in particular the rise of the Chinese middle class were beneficiaries. Stocks that are exposed to working from a home in its broader guise, whether that is e-commerce, electronic payments or anything to do with digitisation or change also worked very well. The market also really began to supercharge the performance of any stock that is linked heavily to environmental change or ESG. These all worked well for most of the year.

We then started to become mindful of the fact that there was the potential for a vaccine emerging towards the end of the year. There were certain areas that have lagged and looked cheap but seemed likely to do well in a recovery once the vaccine came along. The vaccine announcements came in November and led to an improvement in many of those stocks that had done badly but were fundamentally good businesses. A great example of this is Ryanair or Amadeus, which are both linked to air travel. The market extrapolated the rollout of a vaccine to the opening up of international travel, which was very good for both companies. So the key to 2020 was really about being flexible and trying to think very carefully about some of the earnings dynamics of the regime you are in and the fact things are changing quite quickly.

Discuss one stock you identified early

The stock that I think worked best for us in 2020 was Dutch payment company Adyen. This is a stock that we added to at the end of 2019; we had tracked the stock since its IPO and thought its valuation at the time was a little rich. Post IPO it did nothing for quite some time, but we began to look at it seriously towards the end of 2019 and initiated a position. A number of things have helped it, including the pre-existing trends towards greater use of e-commerce in transactions between consumers and businesses and that has helped this. We believe it is the best in class globally at what it does – Stripe in the US is potentially a competitor but no one in Europe comes close. As we went through the period of lockdowns and consumer caution in in their behaviour this stock benefited from two things: the greater penetration of e-commerce and also consumers’ lack of willingness to use cash. I think most of us will probably recognise in our own behaviour we do not use cash much anymore; we tend to use our phones or cards, and indeed many places will not accept physical cash. That has helped Adyen given its focus on payment processing.

Was there a stock you avoided which underperformed?

The stock that on the other side we are most proud of having missed was SAP. SAP is a stock that we have long followed; we have had some concerns over it for quite some time that were building. It was making a lot of acquisitions of cloud-based businesses and not necessarily integrating them well. We were also concerned that it was not really doing enough to shift its own on-premise business into the cloud and offer a fully integrated solution to its clients. What triggered us to sell the stock was the acquisition of Qualtrics. We thought this was a poor acquisition: it was expensive and we thought the diligence done by management was pretty poor too as was its justification for making the acquisition. Sap began to focus on margins rather than top-line growth and given the stage it is at in its on evolution we feel it should really be focused much more on trying to grow the business and making a successful transition to the cloud. We sold the stock about two years ago and were initially surprised at how well it continued to do, but towards the end of the summer it had a profit warning which led to a very severe sell-off in its shares. Effectively the company admitted it was not investing enough in moving its clients to the cloud from the on-premise business and should not have been prioritising margins. We felt vindicated in having avoided the stock.

Why are you positive on European equities for 2021? 

The first reason is we think a number of stocks will really benefit as economies open up over the course of the year. The vaccine has been rolled out in the UK for a number of weeks and has started in Continental Europe and the US. We expect to see, over the course of the first two to three months, a significant rollout of the vaccine to those who are vulnerable or old. At that time we expect to see economies beginning to open up. At the same time, in 2020 consumers were quite constrained in what they could spend. They often were not able to travel, or if they were they perhaps would have gone less far or maybe only gone on one holiday. They have also been restricted in terms of how much they could spend on experiences in their home country, so there is a lot of cash sitting in consumer bank accounts from those who kept their jobs. And for those who are less fortunate, furlough systems and various other fiscal transfers have replaced some of that income. So we think that in 2021 there could be a large bounce back in consumer spending that will benefit many of the stocks that are exposed to this. 

At the same time, going on in the background we also have a lot of the structural trends we have talked about. These include the growth in the Asian middle class, particularly in China, the very strong growth in e-commerce which we think will carry on, the shift in payments from cash to card, the very broad topic of digitisation, which covers many things, and also the focus on decarbonisation and environmental change. These will carry on and, in conjunction with those stocks that benefit from an acceleration in earnings, I think will really help the market in 2021.

How important is it that ESG has always been embedded in your process?

ESG has risen in prominence over the last few years. Like a lot of managers I think we were already doing a lot of the things that are in the ESG acronym. In terms of governance we have been doing our own voting without the use of proxy agencies for several years, engaging with management teams and boards. Where we feel unhappy with their answers we have no qualms about divesting from stocks. In terms of the environment we have also had a number of stocks which are driven by environmental change and those that are going to help the world decarbonise; companies such as Kingspan I have known now for a very long time. We participated in an IPO for a company called Soltec in Spain which is also heavily involved in decarbonisation through solar power. We have held utilities like Orsted and RWE, and Infineon, which is the world’s largest supplier of high-end power semiconductors to electric power trains and EV cars. And then we also have businesses that are best in class in terms of energy efficiency like Atlas Copco and Epiroc. On the S of ESG we have engaged with companies like Flutter on responsible gambling and we have talked to some of the alcohol companies on responsible alcohol consumption. What we have not done, like many of our peers, is necessarily shout about it or document it in a certain way or write about it as much. As we go forward one of the things we will be looking to do is to make it clearer where we stand on certain things and evidence that.

What keeps you awake at night?

Apart from my dog barking, there are some things that keep me awake at night in terms of markets. I think there are a few things that could go wrong in 2021. The biggest is if for some reason the vaccine rollout is disrupted or slower than anticipated. However I do not worry as much about that as I do about policymakers taking a very stringent view on what vaccination, or full vaccination, actually means. We think in terms of risks and probabilities; we would probably say that once you vaccinate those who live and work in care homes, frontline medical staff, over eighties, over 75s, you have a captured much of the risk. But for me the danger is that policymakers in the UK and elsewhere actually define the bar at a much higher level to perhaps encapsulate anybody over 50 or even more of the population. That just takes time, so you would end up in a situation where the bar is set very high in terms of risk and it takes a long time to roll the vaccine out. That would disrupt the opening up of economies. 

More medium term, the types of things that we think about are the strategic competition that exists between the US and China as China has emerged as a superpower. History tells us that often when a superpower rises and challenges another one it can lead to friction. We think about what that means in terms of tangible investing or possible barriers going up, or even in terms of certain things being split; do we end up with two tech ecospheres for example?

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