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Fidelity European Values Trust Plc (FEV.L) Interim Update – 05 October 2014

 

NOTE: Since last covering FEV.L the investment manager has undertaken a share split (see previous report) which has seen the former shares subdivided at the ratio of 10:1.

FEV.L Performance and Portfolio Update

Following what has been a volatile period for continental equities, shares in FEV.L closed this week flat with the level at which we first initiated coverage. After having gained and lost 7% at both peak and trough, a volley of events since late September have led continental equity markets to recoil from their previous peaks, taking FEV.L with them once again.

Despite a largely neutral price performance from both FEV.L and the market, our outlook for the trust going forward remains positive.

In detail, the fundamental drivers behind the European equity story remain in place. Meanwhile at the portfolio level, the investment manager continues to focus on the ability of portfolio constituents to grow dividends in order to bolster returns. All while seeking to avoid getting caught up by chasing lesser quality names during periods of “risk on” trading.

The trust has outperformed both benchmark and its peer group during the later stages of Q2 and into Q3 by remaining disciplined during the market downturns and keeping focused on quality names.

This has proved a welcome development for investors as an overweight position in financials, combined with relatively little exposure to European pharmaceuticals, had previously hampered performance during the earlier stages of the year.

Despite this, the discount to NAV has widened during recent trading and now sits close to the top end of its 12 month range (10.9%), providing scope for a re-rating higher when European indices begin to recover from recent selling.

FEV.L Share Price // Hourly Chart

FEVL

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European Economic Update: Economic Data and Holes in Policy Approach Continue to Highlight Challenges Facing the ECB

While the second half of 2013 heralded positive signs of a nascent recovery on the continent, the first half of 2014 has cast a shadow over the sustainability of this.

Although some previously troubled nations (Portugal, Ireland and Spain) have continued to make progress toward fiscal consolidation and growth, these triumphs have been replaced by increasingly heightened concerns over growth at the very core of Europe.

This is as both Germany and France have experienced a marked deceleration in growth during the first half of the year while bloc-wide inflation has plummeted, to the point where the prospect of deflation now threatens to undermine attempts at fiscal reform.

In contrast, both the UK and US economies have enjoyed robust stimulus-driven recoveries since mid-2013 and are now each on the verge of beginning a gradual tightening of monetary policy. As this scenario of divergent economic health has developed, it has made the challenges faced by the continental economies ever clearer, leading to increasing pressure upon the ECB to act.

Despite the bleaker outlook for growth and reforms, the ECB has, by any measure, been slow to act and now faces accusations of having been behind the curve every step of the way.

More importantly, a large question mark remains over whether or not the current measures put forward by the ECB will be sufficient to halt the threat of deflation and renewed financial instability. The current proposals see the ECB expanding its balance sheet by almost one trillion euros through the purchase of asset-backed securities and covered bonds.  

The key points of criticism in relation to this plan are that the European market for securitisations is remarkably small when compared with that of the US. In addition to this, the ECB already has cold feet over whether or not it would be willing to purchase the riskier and lower rated types of ABS that are available.

This reluctance effectively castrates the central bank’s rescue plan as it does nothing to relieve the balance sheets of Europe’s banks of any real risk. Consequently, the plans are unlikely to result in a notable increase in credit availability within the European economies.

As a result, we continue to expect that the current policy approach will prove to be insufficient and that this will more than likely see the ECB forced to embark upon an outright asset purchase programme during the opening stages of 2015, one which is targeted at sovereign debt markets.

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Summary

All in all, we remain attracted to the European equity story and continue to believe that slow and insufficient action from the ECB will force both the central bank and politicians of Europe to take more drastic action once into 2015.

Despite this belief, the sentiment-driven gains seen across continental markets during the last 18 months have led valuations to expand. This means that earnings growth and the aforementioned robust form of support from the ECB will be key to further gains going forward.

On the downside, geopolitical risks have both risen and receded since our last update, most notably in relation to Ukraine. While a ceasefire is in place at present, the peace is very fragile, which leaves us cautious of the potential for risks to surge later in the year or once into 2015.

Nevertheless, we maintain our pre-existing price target for the shares at 172.00 pence (1,720.00 pre-share split). This implies an uplift of approximately 13% in the trusts NAV (Net Asset Value).

While this may not happen overnight given uncertainty surrounding growth at the core of Europe and the potential for a rebound in geopolitical risks, we believe that the anticipated dividend growth combined with ongoing speculation over monetary policy places it firmly within the realm of possibility for H1 2015.

FEV.L price at the time of writing: 150.40 pence.

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