With all the structural problems plaguing European economies,
most investors now take a dim view toward the Continent. But
Matthew Benkendorf, manager of
Virtus Greater European Opportunities
has successfully navigated these treacherous markets. His fund
ranks among the top 1 percent of European equity funds, according
to Morningstar's rankings. We recently spoke with Benkendorf about
his outlook for the region and he believes there are plenty of
opportunities for the patient, quality-oriented investor.
What is your outlook for Europe?
Europe made a critical error with its response to the 2008
credit crisis. During that crisis, the US initiated programs such
as the Troubled Asset Relief Program (TARP) which it used to infuse
banks with capital. Although that may not have been the intended
purpose of TARP, injecting banks with capital and then forcing them
to raise additional capital turned out to be the right course of
action. European banks did raise some capital at that point in
time, but they didn't do so to the fullest extent necessary.
Instead they took a piecemeal approach with the hope that the
resulting growth from an eventual economic recovery would obviate
the need for additional borrowing.
Even after the equity markets finally rallied off their lows,
European regulators failed to push the banks to strengthen their
balance sheets by raising additional capital. One can draw a simple
contrast between the relative strength of US and European banks
with basic metrics. In terms of tangible common equity (TCE), US
banks are roughly twice as capitalized as European banks. On
average, European banks are at 3 percent TCE to assets while US
banks are at about 6 percent.
It's difficult to know the right level of capitalization, but
the market's action suggests that European banks need more capital.
Unfortunately, it's far more difficult for banks to raise capital
from exiting shareholders after the market selloff.
Beyond that, most entities take a risk-weighted approach to
judging a bank's capital needs. That risk-weighted methodology
examines a bank's asset base and discounts its assets according to
their perceived risk levels. Under that system, sovereign debt
isn't discounted-it's considered sacrosanct because it is
theoretically redeemable at part with no risk. Of course, those
assets do carry risk and, considering the risk to certain sovereign
bonds such as those issued by Greece, the banks probably aren't
sufficiently capitalized to endure losses on those bonds.
Many politicians in Europe are being disingenuous when they say
Greece won't default on its bonds. Greece has over $300 billion in
outstanding debt and there's no way the country can continue to
make payments on it. The Greek debt load should be cut by at least
one half. You can't expect an economy or a population to shoulder
that burden; the Greek population isn't going to struggle for the
next 100 years to pay back Europe for its folly in offering them
cheap financing for so many years. There will be social revolt
before that happens and we're already seeing signs of unrest.
Although most politicians would likely deny it, default is
obviously the endgame. For now politicians are simply trying to buy
some time and hoping for the situation to improve. They're just
delaying the inevitable.
What is the most likely resolution to Europe's debt
The problem with many of the solutions offered thus far is that
they involve raising additional debt to deal with an already
unsustainable debt burden. This approach doesn't make sense.
Nations with stronger economies such as Germany simply can't
shoulder the whole load, and it wouldn't be prudent for them to
try. The other problem with raising additional debt is that it
would be done on a European-wide basis, with every nation
contributing proportionately. It's perverse that some of the weaker
nations would be contributing to a vehicle that quite possibly will
have to bail them out as well.
The cold, hard reality comes down to Europe either printing
money to inflate away its debt or deflating its debt by allowing
debtors to default. Because nobody likes the risk involved in
deflating debt, Europe is more likely to print money.
But for that solution to work over the long term, they'll have
to create greater fiscal integration in the groin, which will raise
a lot of philosophical questions for the Europeans. Fore example,
how much of their sovereignty and national identity are the
individual nations willing to concede?
Are there any bright spots on the Continent?
This is an exciting time because investors ultimately produce
their best returns by buying stocks during such crises. Of course,
investors must still do their research to find the best risk-reward
Our concentrated portfolio focuses on high-quality companies
that have proven track records of profitability and operate in
markets with high barriers to entry. I won't buy a stock simply
because it's been beaten down. I only buy the best, most stable
stocks when the prices are right.
At the moment, multinational consumer staples companies in
Europe offer especially attractive valuations. They've been
consistently profitable and they do a strong business in emerging
We own a number of tobacco names such as
British American Tobacco
(London: IMT, OTC: ITYBY) and
Philip Morris International
). Philip Morris is a Swiss-based business that owns all the
international rights to a portfolio of popular brands such as
Marlboro cigarettes. It's a very predictable and stable business
that gives all of its excess capital back to shareholders.
The food space also offers a number of opportunities, including
(Switzerland: NESN, OTC: NSRGY). In the spirits space,
) throws off a lot of cash and is very attractive to investors. In
addition to its US business, a high proportion of its earnings come
from the emerging markets. For instance, it has a huge share of the
beer market in Brazil.
) is the world's largest spirits maker, boasting a portfolio of
some of the best-known brands, including Johnnie Walker and
Smirnoff. Similar to Anheuser-Busch InBev, it's generating
significant growth from emerging markets.
There are also some compelling health care names. Although most
pharmaceutical companies have pipeline issues with their portfolios
of drugs, there are some opportunities.
) offers the world's best insulin franchise. Because of this focus,
it differs from the typical pharmaceutical company that tries to
compete in five or six different therapeutic areas. As an
increasing portion of the global population becomes diabetic, so
Novo Nordisk has great structural long-term business drivers which
aren't going to change any time soon.
There are also good deals on some durable franchises in the
We hold both France-based
(France: BVI) and Switzerland-based
(Switzerland: SGSN) in our portfolio. Both are global testing and
inspection companies. They inspect everything from testing batches
of toys exported from China, the soundness of the construction of
commercial buildings in France to the quality of grains being
exported from Africa. All those operations capitalize on continued
long-term global growth within a highly consolidated industry while
maintaining high margins and returns.