(Bloomberg News) Top-performing European equity fund managers are bracing for further market declines by hoarding cash and buying "mega-cap" pharmaceutical and tobacco stocks.
Investors held the most cash in three years last month amid the biggest European equity sell-off since October 2008, a month after Lehman Brothers Holdings Inc. went bankrupt, according to a survey by Bank of America Corp. The best performers aren't taking risks any time soon.
"Right now markets look like a freight train and stepping in front of one is never a very good idea," said Philippe Brugere-Trelat, whose 2.6 billion-euro ($3.6 billion) Franklin Mutual European Fund has beaten 90 percent of rivals this year. "We're very risk averse and we're certainly not jumping in the market with both feet."
The failure to resolve the European sovereign-debt crisis and a slowdown in major economies such as Germany, France and the U.S. caused the region's Stoxx 600 Index to fall 10.5 percent in August, the biggest monthly drop in the three years since governments bailed out the world's financial system. Any rebound is likely to be temporary in the absence of a long-term fix to Europe's debt and growth problems, investors say.
Brugere-Trelat, based at Franklin Templeton Investments' office in Short Hills, New Jersey, held 6.7 percent of his fund in cash at the end of July, the latest month for which figures are available. European equity funds typically hold about 2.5 percent of their assets in cash, according to Morningstar Inc.
'Cheap Stocks'
"Cash and diversification are the two main tools we're using" to protect the fund against further falls in equity markets, Brugere-Trelat, 60, said. "There are plenty of cheap stocks around. But a lot of stocks are cheap for the right reasons."
Global investors' cash holdings climbed to 5.2 percent last month from 4.1 percent in July as money managers sold cyclical stocks, those most linked with economic growth, according to the survey by Bank of America's Merrill Lynch unit. Cash balances peaked at 5.5 percent in December 2008.
Olgerd Eichler, manager of Mainfirst Bank AG's Top European Ideas fund, was one of those investors. He held the most cash out of all European equity funds with more than 250 million euros in total assets, according to the latest data available to Chicago-based Morningstar.
Eichler's 383 million-euro fund had 14.4 percent of its assets in cash at the end of May, helping it beat 81 percent of its rivals this year. The fund, which has topped 98 percent of its peers since its inception in July 2007, is down 12 percent this year, compared with a 16.5 percent fall in the Stoxx 600 Index. Franklin Mutual European Fund's is 9.3 percent lower since Jan. 1.
'Unpleasant Speed'
"We're entering a phase of rising earnings disappointments," Eichler, 44, said in an interview. "Many sell-side analysts didn't adjust sufficiently the earnings estimates going forward. This time the slowdown has got very unpleasant speed, and it's not going to turn quickly."
The Frankfurt-based fund manager has reduced his cash holdings since May, investing in "mega caps" such as Royal Dutch Shell Plc, GlaxoSmithKline Plc and Vodafone Group Plc. The average stock in his fund now has a market value of 45 billion euros compared with about 20 billion euros in the first quarter.
"All three enterprises have safe dividend prospects," Eichler said. "If there are flattish equity markets going forward these will be deserving of higher multiples."
Nestle, BAT
It is a sentiment shared by Brugere-Trelat, whose top holdings are Nestle SA, the world's largest foodmaker, and British American Tobacco Plc, Europe's biggest cigarette maker.
"They offer to me the best risk-reward profile in current markets," he said. "They are not as cheap as banks or cyclical companies, but the risk level is considerably lower."
Thorsten Paarmann, 37, at Invesco Asset Management Ltd. in Frankfurt is another manager whose cash holdings, at 8.9 percent of overall assets at July 31, have helped put him in the top 10 percent of comparable funds this year. He increased his fund's cash allocation in anticipation of outflows during difficult market conditions, he said.
Paarmann's 634 million-euro Pan European Structured Equity Fund is down 6.9 percent this year, compared with a 16.5 percent fall in the Stoxx 600 Index. It has beaten 94 percent of peers in the period and has outperformed 96 percent of rivals over the last five years.
'Upward Potential'
In contrast to Brugere-Trelat and Eichler, Paarmann is bullish on European stocks because their current prices are projecting the region's debt crisis to deteriorate and a slowing U.S. economy.
"We do not anticipate another major shock because a lot of things have been anticipated already," he said. "Where we come from now, we see more upward potential than downward risk."
Nevertheless, Paarmann's holdings are in defensive stocks such as British American Tobacco, GlaxoSmithKline and Sanofi, France's biggest drugmaker.
"We tend to have more defensive stocks because the market is not rewarding those with extra volatility," he said. "You can get market returns with below-market risk."
All three managers agree that macroeconomic concerns about the survival of the euro and the health of the world economy are taking precedence in the equity markets over stock picking and will do for the foreseeable future. The biggest influence on stock performance is the decisions made by politicians, according to Franklin Templeton's Brugere-Trelat.
"I see a lot of foot dragging," he said, referring to Europe's political leadership during the crisis. "At the end of the day when push comes to shove they will do the right thing. The alternative is making the Lehman bankruptcy look like a walk in the park."