European Mid-Cap Equities: Portfolio Optimizer to Achieve a Balanced Risk-Return Profile

Europe represents nearly one-third of the world economy, however, European equities as an asset class are largely ignored.

For investors seeking diversification and opportunities in equities, the European Equity asset class provides an ideal stock-picking environment. Western/Developed Europe, and particularly mid-caps, is an equity universe that has the right balance between inefficiencies/returns and stability/quality. Given the extreme inefficiencies and price anomalies in European mid-caps, it can be a great diversification tool seeking above-market returns in high-quality assets. For example, if one would compare European mid-caps with U.S. small-caps, one would discover companies with similar return and growth profiles to their U.S. counterparts, but they typically trade at significant discounts, which inevitably results in higher, long term returns for the shareholder.

Source: Lucerne Capital and PrimeAlpha

KEY TAKEAWAYS: PORTFOLIO DIVERSIFICATION & INCREASING RETURNS

Mid-Cap Europe is an ideal universe for investors seeking long term returns that outperform the market and geographic/sector diversification, which can be achieved through a true fundamental investment process.

The high-quality opportunity set in mid-cap Europe:

• True fundamental investing works: An inefficient marketplace leading to very attractive valuations - high multitude and magnitude of mispricings.
• Many cutting edge companies in Europe: Exceptionally specialized, uniquely high-quality, and growing companies with superb management teams. Companies with high returns, growth, predictable cash flows, strong corporate governance, etc.

WHAT IS MID-CAP EUROPEAN EQUITY?

Despite some short term volatility, ultimately the mid-cap European Equity universe includes exceptionally specialized, uniquely high-quality, and growing companies with superb management teams. These companies would be highly attractive to own for any medium to long term focused investor.

- Mid-Cap stocks in Europe are generally defined as companies with a market capitalization between $2 and $15 billion.

- Despite Europe being made up of over 50 countries, the European Equity Market is dominated by at most 10 countries (think Germany, Switzerland, UK, Scandinavia, etc.), all domiciled in Developed (Western & Northern) Europe.

• Although Eastern & Emerging Europe (think Poland, Hungary, Czech, etc.) are important end markets for many of the corporates listed on the stock exchanges of developed Europe, they tend to lack stable legal and corporate governance frameworks. Additionally, those stock markets tend to be particularly illiquid.

WHAT SORT OF COMPANIES CAN ONE FIND?

At a high level, in almost any sector one can find global leaders that are considered the gold standard within their various industries. Those spanning a wide range from industrials, consumer, financials, technology, and business services to name a few. Different countries and regions in Europe are quite specialized (i.e., France = luxury goods, Sweden = software/engineering, Germany = robotics/industrials, Netherlands = semiconductors), which makes not only their businesses exceptionally efficient, but also their management teams extraordinarily experienced.

Additionally, and contrary to popular belief, there are many cutting edge companies in Europe. Some are high tech and groundbreaking in their own right, creating software to improve manufacturing, education, clean energy, and overall efficiency for many end markets. Most examples though are not the consumer-facing names we all know and love, however, they do support these darlings (i.e. Apple, Google, Netflix, Amazon). They are often integral in one or many pieces of their supply chains. For example, many of the best semiconductor businesses come out of Germany, Austria, and the Netherlands and they continue to grow as their clients do. Some specific examples of these unique, lesser-known companies, of which there are too many for the scope of this piece -

• Sinch (Sweden) - Develops cloud communication platforms. Peer of Twilio (US) trading at 80% discount to Twilio while showing similar growth
• Kahoot! (Norway) - a global leader in edtech partnering with Microsoft
• Helios (UK) - Operator of mobile telephony towers, rolling out 5G in developing markets
• Besi (Netherlands) - key supplier of Apple

The illustration below of European global leaders in their respective fields (just a handful & by no means an all-inclusive list), showing mostly large caps, proving the spheres of excellence within which these mid-caps are operating (think access to skilled personnel, technology, resources, etc.)