As the Greek government races against time to cut its huge budget deficit in order to make any form of financial aid from the EU nations palatable to the European public, one can’t help but wonder how this fiscal crisis will impact the investment outlook for the region as a whole, and whether European companies are still attractive to investors.

When it comes to picking the right European companies to invest in, Paul Casson, fund manager of the Henderson Horizon Fund – Pan European Alpha Fund, is none too perturbed by the current turn of events.

“As fundamental bottom-up stock pickers we do not focus our time in monitoring and forensically analysing economic news flow to estimate growth for the Eurozone. Instead, we look for stocks that should perform the strongest regardless of the overriding economic environment.” However, he acknowledges that “the events of the last two years have meant that, unavoidably, macro factors have played a greater part in building our investment views.”

How has the Greek debt crisis affected the investment outlook for the Eurozone region? How has the fund been impacted by this crisis? Paul tells us more in this interview (see below).

Paul has been a fund manager for over 11 years and is supported by a Pan European Equity team containing seven fund managers. Paul has been managing the Henderson Horizon Fund – Pan European Alpha Fund since July 2008.

iFAST: How does the fiscal crisis in Greece affect the rest of the Eurozone?

Paul Casson (PC): So far the market has obsessed about Greece and the perils of being anywhere near the equity or bond markets of that country.

However, there is a wider picture here, and this concerns the other heavily-indebted southern European countries, notably Spain and Italy.  Greece is a small country that Europe could afford to rescue, but this is not the case with Spain and Italy. The pressure from the European Union is as much about sending a warning to Spain and Italy as it is about directing Greece towards spending cuts and tax hikes.

Despite these warnings, the Spanish government is reluctant to act and seems content in arguing that its situation is somewhat different – a risky strategy with unemployment at 20% and budget deficits to 2013. We believe these sovereign risk fears will blow over when the required action is taken and more peripheral countries follow the Irish discipline of austerity. The fact that it is occurring at the same time as Chinese growth worries, a hike in the Feds discount rate, and a bizarre reaction by Obama to losing a seat in the senate is bad timing and makes people extremely nervous about the chances of a credible recovery.

It was my view at the start of the year that there would be some significant tests for equity markets in 2010, but that they would finish the year higher than they started. This view remains intact, but it appears as though the hurdles that I envisaged have come early in the year, and all at once. If the results season was anything to go by (which went largely unreported due to the sovereign risk fears and China tightening credit), the economic recovery is developing and revenues are beginning to improve again. We believe that this will emerge as the more powerful force, but for now we have to suffer some market volatility.

iFAST: What are the growth drivers for the Eurozone economies in 2010?

PC: Recent economic data and the current reporting season have been largely positive, which would suggest the recovery is ongoing and becoming more deep-rooted. However there are still some structural issues that make it difficult to be bullish on growth in the Eurozone; high all-in labour costs (versus both the US and Asia), an uncompetitive exchange rate, ageing population, higher taxation and heavily indebted governments.

So why invest in the region?

Within Europe you can gain access to emerging markets, but through stable and established companies
Global leaders in niche areas with high barriers to entry
Entrepreneurial leadership and quality company management
Valuation –Europe trades at a significant discount to US and Asian equities

These themes are evident in the long positions of the portfolios that we manage, but we plan to take advantage of those stocks that suffer in the testing economic environment through the use of short positions. In such an economic environment sub-par companies will be punished, which can make short positions extremely rewarding.

Fund Focus: Henderson Horizon Fund – Pan European Alpha Fund

The Henderson Horizon Fund – Pan European Alpha Fund is a sophisticated UCITS III fund, which enables the fund manager to fully express his investment views, whether positive or negative. This ensures that only the highest conviction positions are included in the fund and that its shape closely represents Paul’s market view.

The ability to take short positions allows the manager to control the fund’s net exposure to the market, thus smoothing returns and reducing volatility.

iFAST: The Henderson Horizon Fund – Pan European Alpha Fund is able to take on long/short exposures. What is the current composition of the fund (in terms of its long/short exposures)? What are the reasons behind the fund’s short exposures?

PC: The fund’s current net exposure is 84.4% with gross exposure of 115.4%. The fund’s net exposure has varied from 19% to 96% since launch (chart 1) and is a result of the stock opportunities we are finding on both the long and short side.

In the first half of 2009 we took profits in many of our short positions and reduced the short book from 50% at the start of the year to between 8% and 15% for the second half. This reflected where we were finding new investment ideas – on the long side. Short positions can be useful, but we do not deem them as compulsory, and if we don’t see the potential for gains we will not deploy the capital in this area.

However, since the start of the year we have initiated several short positions. We were short on Electrolux, which was trading at close to an all-time high valuation, despite rising raw material costs that would be difficult to pass on to cautious consumers. They issued a profit warning shortly after initiation, fell 15% and the position has now been closed. With some valuations now looking stretched and volatility increasing in the market, we believe there will be more opportunities such as these to benefit from through the short book.

We have removed some cyclicality from the long book, but on the whole it remains relatively unchanged so that we are able to participate in the rebound that we believe will resume once the current fears dissipate.

chart 1

Source: Henderson Global Investors

iFAST: Does the fund have any exposure to holdings in Greece? How have these holdings been affected, and do you intend to hold on to them?

PC: At the start of the year the fund had two positions in Greece totalling 3.0% of the portfolio. These stocks have suffered in the Greek sell-off, but we continue to hold them as we believe they have been unduly discounted and will rebound once the Greek government implements austerity measures. We also took advantage of the weakness in Greek stocks by adding a position in OTE (Hellenic Telecom), which was trading at a very compelling valuation.

iFAST: According to the fund’s prospectus, the turnover ratio of the fund is 51%. Would you consider this a significant figure? How often does the fund manager change the portfolio’s holdings?

PC: 51% per annum turnover is not surprising given the market environment and that the typical turnover for the fund is 30-40% pa for the long book and 90-160% pa on the short book.

It is also worth noting that on 1st July 2008 we turned over 100% of the portfolio as we ‘adopted’ the fund.

Short positions typically have a lower holding period than the long positions, typically 3-9 months. This is because short positions tend to be initiated to benefit from a negative event anticipated to occur in the near future. Once this predicted event has happened we will close the position to lock in the profits from the downward movement in the share price.

If a short position falls dramatically in the days after initiation, as was the case with some trades in January, we will not keep the position open for the sake of keeping turnover low.

iFAST: The fund is able to invest in equity and equity-related instruments. What are some of the equity-related instruments which the fund has been investing in? How has that worked out for the fund’s performance so far?

PC: We invest in common stock and contracts for difference (CFDs) related to company stock. We have not, and do not intend to, invest in exchange traded funds (ETFs) or derivatives linked to indices.

The ability to take positions through CFDs has benefitted the fund’s performance, with short positions helping to protect capital in the market falls of 2008. The enhanced flexibility of the UCITS III sophisticated fund structure also allows us to have net exposure in excess of 100%. During periods of rising markets this allows us to enhance market returns even before the effect of alpha.

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