Exploiting opportunities in Europe

Running money in Europe isn't the easiest job just now, so how does Mr Dudding limit his losses? "Across both funds I am very underweight financials, a sector which has a lot of risk. My biggest concern is the future of the euro because it puts the future of the banking system in jeopardy and condemns them to low-growth rates. It also restricts lending and, as a result, restricts economies and stocks."

However, on rally days, he admits that the funds will underperform a bit because he does not hold higher beta stocks. He is also underweight domestic facing stocks such as telecoms and utilities.

"I think it is important to know the companies you hold as well as you can to limit downside, and at present both funds are at the low end of what they normally hold," he adds. "I am not a big believer in diversification as I would rather know about my stocks."

European Select holds around 45 stocks, while European Smaller has around 70.

"Just now I am concentrating on companies with decent balance sheets and a good track record of shareholder returns," continues Mr Dudding. "I don't want to get caught out by any fund-raisings. I am very much a growth investor rather than a dividend investor, but am fairly flexible. We like dividends as a proxy of the underlying cash flow and a sign that a company is sustainably generating cash."

The funds are overweight exporters. "Even among smaller companies you can find sectors which are more biased to exports, for example, oil services and engineers," he explains. "However, this is a very popular strategy with many fund managers, as they can see that the eurozone is not attractive. This has made luxury goods and automotive stocks quite expensive relative to domestic-focused stocks."

He is also concerned about a slowdown in the emerging markets, as this would affect exporters.

Company merits

However, Mr Dudding is more of a 'bottom-up' investor - picks shares according to a company's merits rather than economic or sector considerations. "So I don't think of companies as domestic or exporters when I am deciding whether to invest in them, I just try to find ones which can grow through the cycle and raise their prices. If they can do this I don't care if they are domestic-facing."

An example of this is shipping company Irish Continental Group, which runs ferries between the UK and Ireland. "We like it because over the last two years a lot of capacity has come out of its market as the Irish economy contracted and there is less travel. With fuel prices up, these companies, for example, airlines and smaller ferry firms, have struggled. So Irish Continental Group is in a good position because the competition is on and it could raise prices. The share offers little growth, but has virtually no debt and offers a high dividend yield. Pricing power is what we are trying to find across the board."

This company aside, however, Mr Dudding has very little exposure to the troubled areas of Europe known as the PIIGS (Portugal, Italy, Ireland, Greece and Spain). "This is because I am very biased to pricing power, so I am underweight a lot of the commodity stocks. Spain, meanwhile, has some of the biggest banks, telecoms and utilities, and I can't find the right stocks in these countries. The geographical allocation is a result of the stock-picking."

He has not changed his investment approach following the problems in Europe. "I took on the European Select Fund in July 2008 and have been underweight financials since," says Mr Dudding. "I'm a growth investor and biased to companies which can make their own destiny. For example, I would rather pay more for an oil services company than a producer."

But valuations are still an important investment consideration. "We would never buy overvalued stocks," says Mr Dudding. "If one of our holdings hits our price target we tend to sell it, though if it is slightly overvalued we might do nothing. Valuations are not unimportant, but we are quite focused on the business models.

"We are more qualitative than many of our peers and have a slightly longer-term strategy. For example, we like to see how a company sits in relation to its customers and suppliers, and if its growth is sustainable and why. Plus we have a bias to quality stocks."

Buy Europe

Despite the sector boasting some of the best shares, funds and managers, Europe is still a hard sell to UK investors. "European valuations are cheap, while over the last five years Europe has performed better than the UK or the US," counters Mr Dudding. "Listings are geographically meaningless: take Unilever, which is listed in the UK and Netherlands but makes more than 50 per cent of its sales to emerging markets. People are far too negative and always think there is a strong correlation between gross domestic product (GDP) and investment returns. This is not true - certainly over the short and medium term."

He explains that continental stock markets offer some fantastic multi-nationals which are long-term winners, but on much lower valuations than UK shares. "There are not many software companies better than SAP or food companies better than Nestle," he says. "Investors who shun Europe risk are missing out on very well run companies."

He also points out that some of the European economies are strong, too - singling out Germany and Sweden for being much stronger than the UK. "If the euro collapses, lots of British companies will have problems with their share price as well, while valuations on continental stocks are discounting the worst case scenario," he says.

Read more on European opportunities

There are also far better opportunities for smaller company investors.

"Europe is probably a less efficient market than the UK and you can find genuinely undervalued shares because not so many analysts cover it," he says. "In the UK they pick them up much quicker."

IC memories

Have Mr Dudding's days at the IC had influence on what he does now? "Investors Chronicle is what got me interested in investing," says Mr Dudding. "I now look at a lot of the Irish stocks we covered at the IC. I didn't look at European stocks back then, but lots of the companies we now invest in are competitors to what I covered at the IC, for example, Umicore which is in the same space as Johnson Matthey (a FTSE 100 chemicals company).

"Bearbull always struck me as a good column and Coppock has a good track record with market levels. But I don't always agree with them!"

Also read our interview with former IC hack turned fund manager Mark Slater

Source: Morningstar, *Threadneedle.

Performance data as at 7 December 2011.

Top ten holdings as at 31 October 2011

Geographic breakdown (%)