After a brief pause in the first quarter, international equity markets moved higher, ending the second quarter of 2014 with positive absolute returns across the board. Canada and the UK were the best performing major markets, while both Europe excluding the UK and developed Asia lagged. Emerging markets also performed well as investors began to anticipate an end to negative earnings revisions. Overall, the world seems to be moving from a market driven by Central Bank actions, as evidenced by 2013’s higher beta performance, to a market that focuses more on less volatile companies with durable earnings growth and trading at reasonable prices.
Invesco European Growth Fund (Trades, Portfolio) Class A shares at net asset value (NAV) posted a return of 3.81% for the second quarter of 2014, outperforming the MSCI European Growth Index, which returned 2.86%.
Stock selection in financials, industrials and health care drove relative outperformance. Having a meaningful overweight in energy, the quarter’s strongest sector, compared to the index also added to relative return.
Fund holdings in the financials, health care and industrials sectors outperformed those of the benchmark and were among the strongest contributors to relative performance.
Shire PLC (LSE:SHP) and Haci Omer Sabanci Holding AS (IST:SAHOL) were among the most significant individual contributors to fund performance during the quarter (2.08% and 1.88% of total net assets, respectively.)
Shire (LSE:SHP) is an Irish-based global specialty biopharmaceutical company. The company’s stock price rose as it was the object of a takeover bid by a US drugmaker.
Haci Omer Sabanci (IST:SAHOL) is a conservatively managed Turkish holding company, of which Akbank T.A.S. is the largest holding. During the second quarter, shares of Haci Omer Sabanci rebounded strongly from a deeply sold-off position at the end of the previous quarter. Improving sentiment toward Turkey and emerging markets in general drove the stock’s rally.
Stock selection in the consumer discretionary sector was a key detractor from relative results. An underweight in consumer staples, a sector we still consider overvalued, hurt relative results as well. However, the consumer staples stocks the fund did hold outperformed the index sector.
A higher-than-average cash position during the quarter was a drag on results.
Balfour Beatty PLC (LSE:BBY) was one of the largest individual detractors from fund performance during the quarter (0.69% of total net assets). Balfour Beatty is a UL-based multi-national infrastructure company with interests in construction and support services and infrastructure investments. The company released a profit warning and announced the possible sale of its professional services business. The UK construction environment remains challenging, particularly for the most profitable large infrastructure projects. However, a rapid rise in construction margins from current low levels should lead to a significant rise in both earnings expectations and investor interest.
Positioning and Outlook
During the quarter, we continued to look for opportunities to improve the portfolio’s growth potential and quality by adding and/or selling stocks based on the team’s earnings, quality and valuation or EQV outlook for each company. As a result, we added two new holdings to the portfolio and sold four holdings.
Additions to the portfolio were German multi-national sporting goods company Adidas AG (XTER:ADS) and UK-based global real estate services provider Savills PLC (LSE:SVS) (0.74% and 0.50% of total net assets, respectively).
Weakening fundamentals led to the sale of Swiss multi-national food and beverage company Nestle SA (XSWX:NESN), German telecommunications company Deutsche Telekom AG (XTER:DTE), Belgium-based automobile distributor and services provider D’leteren SA (XBRU:DIE) and UK-based defense and countermeasures company Chemring Group PLC (LSE:CHG) (all 0.00% of total net assets).
From a broad market perspective, European valuation levels appear favorable relative to other regions but earnings have yet to see a normal recovery from the recession. Japan’s correction so far this year has improved valuations, but critical structural reforms in Japan may prove to be elusive in the near term and quality opportunities remain scarce. Emerging markets began to show signs of stabilization, which has increased focus on the region, but most emerging market economics remain fragile, and economic recovery across the region is expected to be in consistent. In sum, we continue to believe that improvements in broad corporate and economic fundamentals are struggling to keep pace with rising expectations for economic acceleration in the second half of 2014.
As always, regardless of the macroeconomic environment, we remain focused on our long-term, bottom-up investment approach to identify attractive companies that satisfy our EQV investment process.
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