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BusinessWeek.com
May 16, 2006
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An Eclectic Eye on the Continent

Henderson European Focus Fund's Stephen Peak has beaten his peers by ranging across market caps, styles, and sectors

Considering sending some of your assets on a European trip? The Henderson European Focus Fund (HFEAX ) traverses the Continent seeking performance from stocks of any size, style, or country of origin. Lead manager Stephen Peak uses a bottom-up stock-picking approach based on fundamental analysis to hone in on top-10 holdings like Norwegian oil-rig company SeaDrill and Italian asset manager Azimut.

European equities have been unjustly overlooked, according to Peak, who says the shares offer not just diversification, but also pockets of opportunity. "The U.S. economy has been a better economy, no question," he says. "But this fund is not called the European GDP Fund."

In fact, the London-based portfolio has turned in average annualized returns of 43.1% for the three-year period ended Apr. 28, according to Standard & Poor's. That compares to 30% for its style peers and 27.3% for the S&P/Citigroup PMI Europe Index. The fund has posted average annualized returns of 34.26% since its Aug. 31, 2001, inception, and it carries a four-star overall S&P rating.

EURO-EXPENSIVE.  While the portfolio keeps 28% of its assets in British-based holdings, as of quarter-end Mar. 31, it also has exposure to the emerging nations of Eastern Europe. One top-10 position, Russian oil giant Gazprom, in April passed Microsoft (MSFT ) as the world's third-largest company by market value, behind only General Electric (GE ) and Exxon Mobil (XOM ).

Still, a continental jaunt doesn't come cheap, as the fund's 2% expense ratio is higher than its 1.57% peer average, according to S&P. The fund also charges a maximum front-end sales load of 5.75%.

Peak recently spoke with BusinessWeek Online reporter Marc Hogan about the fund's recent purchases, and his approach to stock-picking. Edited excerpts from their conversation follow:

To start, let's talk about what the fund does. What's your investing philosophy?
The fund has three clear objectives. One is to make money, one is to outperform the market, and the other is to beat the competition. If you can do all three, then those are the components of success.

How do we achieve those objectives? Again, there are really three clear elements. One is that this is a bottom-up stock-picking fund. It's not run by a committee that allocates money to Germany, France, or anywhere else. Having said that, there's diversification geographically, and it's diversified by industry and sector. It's all about having diversification, but with a good focus on money-making ideas.

Key point two is the style of the fund. As you know, most commentators like to put people in a nice little box. This is not a growth fund. It's not a value fund. The best word I can use to describe it is "blend." In other words, if there are great growth ideas, fine, we'll have great growth ideas. If there are great value ideas, we'll have great value ideas. My job is to be the chef: I change the recipe to go wherever the best ideas are.

Point three is really the capitalization spread of the fund. I am an all-cap investor, so I will look at the biggest companies in Europe, the Vodafones (VOD ), all the way through to companies you've never heard of that have $100 million to $300 million by capitalization, and the midcaps in between. The portfolio will always be spread across the different areas, but we have the potential to be comfortable moving up-cap and down-cap as we go through different cycles of the market.

So is small-cap where you see opportunities now?
There are always opportunities in small-cap. In terms of companies, there are fewer big companies than there are small. Still, small-caps in general have had such a terrific run that it's becoming increasingly difficult to find great opportunities. You still can find some...but as far as fantastic opportunities that just blow your socks off, it's difficult to find too many.

If we can find good opportunities within large-cap, and there should be some, maybe we'll shift to large-cap even more. But it's not a plan or a promise. We have to react to the opportunities we see week to week, month to month.

Any recent examples?
We initiated in the last month a position in Bayer (BAY ). The company has just made a major acquisition, Schering (SHR). The story is a very simple one: Bayer is transforming from a chemical company to one that effectively, through the deal, becomes a pharmaceutical company, or life sciences, if you prefer. That has got ramifications for how you should view the business makeup, and we think ramifications for valuation. That's now a top-five position in the portfolio.

I noticed a couple of your top-10 holdings were in Norway. What drew your interest there?
We're not wedded to country picks, but you've got to have diversification. Norway has been a very successful area for us. We have one oil company holding there, which is Statoil (STO ). It's quite sensitive to the oil price in its structure. We've held that position for a while. Oil prices have done well, and many of the oil equities have been pretty decent performers over time on the back of that.

The other one we have is SeaDrill, an oil-services company. You're probably familiar with Transocean (RIG), a big U.S. name, and this is similar. But it's very much a younger company. We only bought it in the beginning of the year, and we think that the best is yet to come.

What are some other stocks you like right now?
Pfleiderer is a company we've held for a couple of years. It was a very small German company, operating in an unspectacular area, engineered wood products. When we came across this company, the industry was over capacity, but that was changing. Many of their competitors were indebted, and the banks were moving in and shutting off capacity. More pricing discipline was coming into the market, which was fairly good for Pfleiderer.

The [company] embarked upon a program of selling off noncore assets, focusing on the main business line. They have some interesting emerging European exposure, and everything looked good. But with any small company, you need an opportunity to buy the shares. Sometimes you find a great idea and you can't buy any shares. In this company, a major block of stock was sold by two Pfleiderer brothers. Not only did we find a good idea that had potential and we thought was significantly underpriced, we also had a way to consummate that. This company is now a $1 billion company, and we've held it all the way through. We still think it has upside potential.

I've mentioned a couple of German names already, but another of the ways we've done that is through the financials. We've been playing companies like Commerzbank (CRZBY ), where fundamentals are improving. On the whole, the German domestic economy itself has actually been showing signs of life.

How do you take into account the rising interest-rate environment globally?
It's a fact you bear in mind. I'm not a macro, or top-down, investor, but clearly you have to keep in account, What do we think about economic growth in that country? What do we think about interest rates globally? If you have a company with a lot of short-term debt and you think the short rates are going to go up to 10%, that's an issue. So that blows back and affects your stock selection.

What's your methodology for picking stocks?
It's very fundamentally based. I run a team of 12 investment professionals, all with some specific skill: specialist small-cap, specialist large-cap, etc. They run portfolios, and some of their ideas find their way into this fund. We spend most of our time seeing companies. Being in London is pretty helpful. It's a good crossroads of corporate traffic. We have a number of one-on-one meetings every day. That gives you the ability to meet the management, hear them talk about their strategy, and also in subsequent meetings check that they've actually done what they said they're going to do.

What we're really trying to do is to understand the business. What are the drivers? What are the issues of that business? Why are margins 2% when everybody else is over 10%? Is it because there's some cost structure that can be dealt with, or are the 10% margin companies going to migrate down to 2%?

We've got about 70 positions now, and I think they're pretty good positions. What drives me forward is I know there are some good ideas we don't have in the fund. I'm not sure where they are, but that's the day job.