Seeking diversification in uncertain times

Over the past decade, global equities, bonds and asset prices, in general, had a fantastic run and being long any asset class, ideally levered, was the right strategy. With persistent inflation here to stay combined with geopolitical tensions and a potential global trade war, that continues to contribute to market instability, alternative long-short strategies should in our view move back into the spotlight.

Adding alternatives to a core portfolio can help to provide a more defensive tilt but also can enhance returns in inflationary times. Additionally, lowering the dependency on market direction in such periods is also welcomed by investors.

Carmignac Portfolio Long-Short European Equities is a suitable solution for investors looking for a dynamic and flexible exposure to European equities through long and short alpha generation combined with a strong downside risk management.

The positive performance of the equities markets in 2024 has been followed by a sharp decline in the first quarter, with the volatility expected to continue, especially in the US. The recent increase in rotation and dispersion appears healthy, as equity crowding had reached unsustainable levels. In Europe, significant tailwinds are being experienced that we haven’t witnessed in a long time. Although periods of volatility, similar to recent weeks, are possible, the overall trend for the region remains positive in our view.

The actions of the Trump administration have served as a wake-up call for Europe, driving the region towards greater independence, especially in military capabilities. It has also prompted Germany to undertake a significant fiscal stimulus, a move comparable in magnitude to both the Marshall Plan after World War II and the reunification efforts of the 1990s. The German economy is seeing a shift in its economic policy by removing the fiscal drag and its upcoming historic investment in defence and infrastructure are also expected to have a significant impact on the region that is expected to lead to improved efficiency and productivity that will benefit companies in the related sectors.

In the short term, the euro area economy faces a weaker global backdrop (with an expected recession in the US, tariffs, persistent uncertainty and higher real interest rates) before fiscal measures kick in. However, inflation risks being skew to the downside should support more monetary easing.

From a valuation perspective, European equities offer double the premium of US stocks, demonstrating an attractive option for investors seeking to diversify into value stocks. This is especially relevant as valuations of major US stocks appear increasingly overvalued. These factors collectively highlight the strengths of European equities, suggesting that sectors such as defence, infrastructure, and value stocks are particularly advantageous for investors to focus on today.

A long/short approach to European equities offers several distinct advantages:

• Firstly, it provides diversification by balancing long and short positions, thus reducing market sensitivity, potentially offsetting losses with gains from short positions.
• Flexibility is another key benefit, allowing dynamic adjustments based on prevailing market conditions. As we see multiple structural changes in the European equity markets, such as deglobalization and varying fiscal policies, this presents opportunities for active long/short investors to uncover hidden value and achieve higher returns.
• Lastly, the long/short approach performs well in volatile markets. We observe high stock dispersion since the beginning of the year with a lot of sector rotations, providing investors the opportunity to identify winners and losers in changing macroeconomic environments and effectively navigate difficult markets.

Carmignac Portfolio Long-Short European Equities, adopts a fundamental, bottom-up, equity long/short investment approach, primarily investing in mid to mega-cap companies across Europe. Each position in the portfolio is backed by a well-defined investment thesis, forming the core of our investment process as well as our sell discipline. Typically, the portfolio consists of 60 to 80 positions: around 25-35 long positions and 35-45 short positions.

The companies we invest in on the long side are key global players operating in oligopolistic industries with high barriers to entry. Notably, only 40% of the revenues of companies in the Stoxx 600 index are generated within Europe, indicating strong revenue diversification outside the region. For example, SAP, one of our largest long positions, is a leader in enterprise software and generates most of its revenues globally. The Fund allocates across Western Europe and does not target a particular allocation by country. We have currently most exposure to Germany, France, Italy, Netherlands, and Switzerland.

Lastly, ESG is fully integrated and based on a 5 pillars approach: negative screening, ESG analysis, carbon target, monitoring of the PAIs and stewardship activities. Our negative screening includes ethical and sectorial exclusion of companies involved in controversial activities such as controversial and conventional weapons, thermal coal, power generators, oil and gas extractors, adult entertainment, tobacco, and gambling. Additionally, we exclude companies with low governance ratings or high carbon emissions.

Lastly, as an active owner, we engage with companies’ representatives including management and boards.