Review of the quarter to 30 June 2023.

The fund made 2% in the second quarter, outperforming its benchmark, the FTSE World Europe ex UK index, which made 0.6%, and its IA Europe ex UK peer group, which lost 0.4%.

In our first-quarter note, we pointed out that the market had become fixated on the two US banks that went bust and the potential contagion beyond Credit Suisse in Europe. As we pointed out at the time, while the wider European banking sector saw earnings per share fall by about 2% per annum between the financial crisis and the pandemic, share prices had been falling by about 4% per annum as more bad news was discounted. And while Credit Suisse's earnings per share have plummeted over the past few years, the sector as a whole has been delivering superior growth.

Our positivity on the sector paid off this quarter, with three banks – Italy's UniCredit, Greece's Piraeus Financial Holdings and Germany's Commerzbank – in the top-10 contributors to performance.

Other non-bank financials accounted for another three of the top-10 contributors to performance in the quarter, again aided by the impact of rising interest rates.

Among the biggest detractors from performance were Dutch chipmaker STMicroelectronics and, from Turkey,
retailer BIM Birlesik Magazalar and bank Turkiye Is Bankas.

The share prices of the Turkish stocks rose over the quarter, but a significant fall in the value of the lira following the re-election of president Recep Tayyip Erdoğan resulted in a loss for UK investors. We reduced our position in both holdings, as well as in another Turkish stock, industrial Turkiye Sise ve Cam Fabrikalar.

STMicroelectronics' share price peaked before the start of the period in question and although it subsequently beat first-quarter forecasts, it fell due to worries about a slowdown in the wider semiconductor industry. It is already showing signs of recovery, however.

Activity

We increased our weighting to pharmaceuticals, adding to our positions in GlaxoSmithKline and Novartis, although we continued to reduce our holding in Bayer. We remain significantly underweight the sector.

We sold our holding in Nokia. This is a stock whose share price has closely tracked its relative earnings per share (adjusted for dividends paid) over the long term, so when the latter measure overtook the former on the way up in November 2021, we bought in. However, while the relationship between the two still holds true, the direction of travel is now downwards. We sold in April.

Outlook

One of the major trends since the financial crisis in general and 2017 in particular has been the increasing dispersion of valuations – 'value' stocks have become abnormally cheap and 'growth' stocks abnormally expensive.

MSCI Europe Value vs MSCI Europe

Value stocks are always on a lower rating than the market (black line below the red line – that is why they are 'value' stocks). For the three decades to the mid-noughties, and indeed for the prior 70 years, they delivered good growth (red line heading up) and so value investing was successful (black line going up).

From 2007 to 2020, both lines have been going down and value investing has become deeply unpopular. Over this period, the black line fell faster than the red line (value stocks were de-rated). In essence, by 2020, the market was anticipating continued falls in the red line (fundamental value per share relative).

However, for the past few years, the red line has been going up again. This is inconsistent with the rating which requires the red line to keep heading south. Investors are fixated on the black line (has it rolled over, are we going back to the days when growth stocks are the big winners?). We are fixated on the red line and the implications for the black line. To make the point, I extended the lines forward by five years – the red line goes back to its pre-2007 gentle upwards trend and the relative rating on value stocks goes back to normal (pre-2017 average).

This would imply value stocks beating the market by almost 6% per annum. And you wonder why the SmartGARP funds all have a bigger value tilt than normal.