Knowing how – in the fast lane with European value stocks: M&G (Lux) European Strategic Value Fund

While growth-orientated mega caps are once again setting the tone at a global level this year, a completely different trend is emerging in Europe. Here, value stocks, which have been neglected for a long time, are currently enjoying a tailwind. The MSCI Europe Value Index has outperformed the broad MSCI Europe Index and the growth-orientated MSCI Europe Growth Index this year. In our view, this trend could continue since the valuation discount for value stocks in Europe is still historically high.

Even if this value tailwind comes in handy, we are of the opinion that a solid value approach can keep up regardless of the dominant market style. Since launch in February 2008, the M&G (Lux) European Strategic Value Fund has not only outperformed the broad MSCI Europe Index, but also the MSCI Europe Value Index. And this in a phase in which value shares lagged far behind the broad market.

The value and income from the fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested. The views expressed in this document should not be taken as advice or forecast nor considered a recommendation to purchase or sell any particular security. 

Total return in %, 02.02.2008 – 31.10.2024

Past performance is not a guide to future performance.

Source: Morningstar, 31 October 2024, EUR A Acc share class, income reinvested, price to price, net of all fees. Performance data does not take account of the commissions and costs that may incur on the issue and redemption of units.

What is the recipe for success?

Since February 2008, we have been pursuing a value strategy based on a well structured and repeatable investment process. This is divided into three steps:

1. Screening: In the first step, the overall market is divided into individual sectors, within which the cheapest quartile is filtered. The subdivision into sectors is intended to achieve a diversified sector allocation. The key valuation criterion for the stock selection is the adjusted price-to-book ratio. ‘Adjusted’ means that factors such as research and development expenses and inflation, among others, are included in the calculation of book value to reflect the true replacement cost of the business as realistically as possible. 
   
   
2. Fundamental analysis: In the second step, in-depth fundamental analysis is used to eliminate so-called value traps and select companies with an attractive risk-reward. Value traps are stocks that have a low valuation for good reason because they are struggling with problems that are usually difficult to overcome. Examples could be an over-indebted balance sheet, a generally shrinking business field or uncompetitive products. 
   
   
3. Portfolio construction: The third and final step involves putting together a targeted and balanced portfolio of 60 to 100 stocks from a bottom-up perspective. The aim is to achieve a healthy balance between cyclical and defensive value stocks. It is also crucial that the portfolio has an attractive valuation discount compared to the broader market.

We have been pursuing this particular approach with our fund for more than 15 years, and have remained true to our value style even in the face of adversity. We believe that this has been instrumental in helping us to overcome the various challenges associated with value stocks over the last decade.

Stock selection as the key success

As a purely bottom-up driven approach, the fund's objective is to add value, much of which should come from stock selection beside the value style. And that is precisely what the fund has achieved (see table). While sector allocation relative to the benchmark, the MSCI Europe Index, has provided only a moderate advantage overall this year (with one exception, see below), stock selection derived from the clear three-stage investment process has been the main driver of excess returns year-to-date.

Performance attribution of the fund relative to the MSCI Europe Index, 01.01. – 31.10.2024

Past performance is not a guide to future performance.

Source: Factset, 31 October 2024, performance attribution gross of fees.

The overweight in the banking sector has paid off

The positive contribution of the stock selection within the financial sector has been particularly striking this year. This contribution comes mainly from banks. It was only last year, with the regional banking crisis in the US, which also led to price losses in the European banking sector, that we started to increase our weighting in the banking sector.

While market participants were increasingly concerned about banks' margins due to the expected interest rate cuts, we believed that these concerns were exaggerated and that they had already been more than priced into the markets. Many banks have used the last few years to hedge their books. As long as the economy does not permanently return to the world of zero or even negative interest rates, which is highly unlikely in our view, we believe that many European banks should be able to generate decent profits.

The market now seems to be slowly realising this, which has led to an impressive recovery from which our fund has been able to benefit. Among the banks in the portfolio that have performed particularly well in this phase are the two British banks NatWest and Lloyds, the Spanish Caixabank and the Austrian Erste Group.

Stock examples outside the banking sector

But even outside the banking sector, the structured investment process has led to some winners and potentially very promising stock companies that many market participants have not reckoned with.

UCB – a prime example of our three-stage investment process

The Belgian pharmaceutical company was added to the portfolio back in 2019. At the time, the company already had approval for its psoriasis drug, the potential of which was significantly underestimated by the market. As a result, the company's valuation was very cheap relative to the healthcare sector as a whole based on our preferred metric of the adjusted price-to-book ratio, which includes the research and development costs which is a crucial part for pharmaceutical companies like UCB. While the share price trended sideways for a long time, this year market participants suddenly came to the realisation that the actual value of the business could be significantly higher, resulting in a price increase of over 130%. UCB is thus a prime example of applying the three-stage investment process and our patient approach.

Tesco – potentially the beginning of a longer upward move

We added the British supermarket operator to the portfolio in October 2020. At the time, the stock was considered a value trap by many market participants after the well-known value investor Warren Buffet sold the stock at a loss in 2015. In fact, the stock was unattractive for us at the time as well, mainly due to the weak balance sheet. However, the situation changed fundamentally after the sale of the US and Asian business activities and the focus on its core competencies. The company's balance sheet suddenly looked much more solid. The company is no longer pursuing the aggressive expansion strategy that led to the problems at the time. Instead, Tesco is now looking for other ways to grow. For example, the company has already been able to successfully gain market share with the Tesco Clubcard. The opening of the online shop could open up further growth potential in the future. After a long sideways phase, the market has now begun to reward the significantly improved fundamentals with rising share prices. Ultimately we think that with Tesco we were able to buy a company with a strong market position, solid balance sheet and good management team at a very favourable price.

Hornbach – a huge potential just waiting to be discovered

The German DIY store company that is already a portfolio holding since 2011 is very attractively valued and, in our view, is currently hugely underestimated by the market. The company is very well managed and has an extremely solid balance sheet, which in our opinion contains massive hidden reserves in the form of real estate and land assets. That means that from the perspective of net assets alone, we consider this company to be a real bargain. In addition, Hornbach has a very strong market position and is continuously gaining market share in its very competitive domestic market Germany, but also in countries outside Germany, such as the Netherlands or the Czech Republic. In our opinion, the solid balance sheet could enable the company to squeeze out their usually much weaker competitors in the long term. Even though the stock has been stuck in a tough sideways trend for many years, we believe that it is only a matter of time before the market recognizes the massive undervaluation and rewards it with rising valuations. Until then, we will have to exercise patience, as we have successfully done in many other cases before.

The outlook still looks very favourable for European value stocks

In our view, the market regime has changed fundamentally. The era of  zero interest rates seems to be over and fundamentals are coming back into focus. In addition, valuations are once again playing a decisive role in times when growth expectations are subject to great uncertainty. In such a regime change, new market leaders are likely to emerge. The next few years could therefore prove to be highly favourable for value investors.

With our disciplined and patient value approach, we believe we are well positioned to take advantage of the potential tailwind for value stocks in Europe, while also delivering tangible added value through robust stock selection.

Fund description

The fund aims to provide combined income and capital growth that is higher than that of the European stock market (as measured by the MSCI Europe Net Return Index) over any five-year period while applying ESG (environmental, social and governance) criteria. At least 80% of the fund is invested in a value-style portfolio of shares in companies domiciled, or conducting the major part of their economic activity, in Europe. The fund is invested in cheap, out-of-favour companies whose share price, in the investment manager’s view, does not reflect the underlying value of the business. Stocks are selected on the basis of their individual merits, through a combination of value-focused screening and qualitative assessment. The fund invests in securities that meet the ESG criteria, applying an exclusionary approach and positive ESG tilt as described in the prospectus. The fund’s recommended holding period is five years.

Main risks associated with the fund:

• The value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested. 
• The fund can be exposed to different currencies. Movements in currency exchange rates may adversely affect the value of your investment.
• ESG information from third-party data providers may be incomplete, inaccurate or unavailable. There is a risk that the investment manager may incorrectly assess a security or issuer, resulting in the incorrect inclusion or exclusion of a security in the portfolio of the fund. 
• Please note, investing in this fund means acquiring units or shares in a fund, and not in a given underlying asset such as a building or shares of a company, as these are only the underlying assets owned by the fund.
• Further details of the risks that apply to the fund can be found in the fund’s Prospectus available on our website.

Sustainability Information:

The Fund promotes Environmental/Social (E/S) characteristics and while it does not have as its objective a sustainable investment, it will have a minimum proportion of 20% of sustainable investments.

The Fund’s sustainability information is available to investors on the Fund page of the M&G website. 

Fund performance

Past performance is not a guide to future performance. Performance data does not take account of the commissions and costs incurred on the issue and redemption of units.

Performance: 1 month, year to date and year to most recent quarter (%)

Benchmark*  = MSCI Europe Net Return Index

The benchmark is a comparator against which the fund’s performance can be measured. It is a net return index which includes dividends after the deduction of withholding taxes. The index has been chosen as the fund’s benchmark as it best reflects the scope of the fund’s investment policy. The benchmark is used solely to measure the fund’s performance and does not constrain the fund's portfolio construction. The fund is actively managed. The investment manager has complete freedom in choosing which investments to buy, hold and sell in the fund. The fund’s holdings may deviate significantly from the benchmark’s constituents.

Fund performance prior to 20 September 2018 is that of the EUR Class A Accumulation of the M&G European Strategic Value Fund (a UK-authorised OEIC), which merged into this fund on 7 December 2018. Tax rates and charges may differ. 

*From 1 January 2012 to 19 September 2018 the benchmark is the MSCI Europe Index stated as Gross Return. From 20 September 2018, the benchmark is the MSCI Europe Net Return Index.

Source: Morningstar, Inc and M&G, as at 31 October 2024. Returns are calculated on a price to price basis with income reinvested. Benchmark returns stated in EUR terms. Performance data does not take account of the commissions and costs incurred on the issue and redemption of units.

Find out more about the fund