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Tuesday, August 07, 2012

Buy Ugly

Yesterday my son called to check in and talk alligators, fishing and baseball. While we were at it he wanted to rebalance his 401k as his company made changes in the offerings available to him. After some discussion we settled on a mix of large value stocks, Europe and Energy. I’m not a huge fan of domestic blue chips right now but he is 24 and will be dollar cost averaging on a bi-weekly basis for many years so I can live with them in his portfolio. The other funds were the cheapest asset classes available to us in the mix. Had there been a real estate or bank stock fund we would have allocated to those beaten up sectors as well. I am trying to build a portfolio of the cheapest assets available so that over time he benefits from the inevitable long term reversion to the mean. If the world doesn’t end he will do very well with this approach.

I talked yesterday about how cheap I think real estate is from the perspective of a long term investor. I have also talked at length this year about energy and the cheap assets available in that sector. Both of these continue to be true. I have talked a little about Europe and have been a buyer of selected large European financials like Royal Bank of Scotland (RBS) and Aegon (AEG).  I have hinted about Europe a few time and even suggested that ETFs for Spain and Italy might be a reasonable speculation.  When I look at cheap assets around the world the simple truth is that Europe is cheap and has to be considered by long term patient investors.

The losses in European markets have been fairly substantial and this is creating compelling investments opportunities for long term investors. This is not a clarion call that Europe has bottomed and should be bought with abandon. The financial situation in the old world is still a mess and despite positive rhetoric form financial leaders no clear solution has emerged. The markets will still be news driven and extraordinarily volatile in my opinion. However buying during periods of great turmoil has been a successful strategy for long term investors as long as there have been markets.

I thought it might be helpful to look at what some of the leading value oriented European funds have been doing during these volatile times. One of the more successful finds has been the Royce Europe Small Cap Fund. Even after a 20% loss in 2011 the fund has one of the best 3 and 5 year returns in the class. The fund has the bulk of its assets in the northern European nations that have fared much better than the troubled southern sunny European nations. They are heavy in Germany and the UK and very light in financially stressed nations like Spain, Ireland and Portugal. Fund manager David Nadel recently told the LA Times that he is looking for companies that sell their products globally with an emphasis on those that have significant exposure to emerging markets.  Two stocks he highlighted were Pfeiffer (PFFVF), a semiconductor company and Victrex PLC (VTXPF) a UK plastics company. The funds top sectors are healthcare, and technology.

That also seems to be the approach favored by the value investors at Mutual European fund, the Franklin Templeton (BEN) offering that traces its roots back to Michael Price, Max Heine and the roots of value investing. The majority of the fund is in the UK, France, Germany and Switzerland with limited exposure to the more troubled nations. Top holdings are large multinational companies like Vodaphone (VOD), British American Tobacco (BTI) and Royal Dutch Shell (RDS-A).

Europe is a mess and it is probably not going to be pretty again anytime soon. However there is an opportunity to buy ugly and prosper over time. Along with real estate and energy Europe is cheap on historical measures and should provide very attractive long term returns for patient investors who can stomach the volatility.

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