Best European Stock Bets

October Hedge Funds: Best, Worst, Biggest

Jonathan Herbert doesn’t share other investors’ deep anxiety about a recession in Europe.

One
of the region’s best-performing equity hedge fund managers this year,
the Swiss native runs the Camox fund, a value-driven long-short investor
based in London. Herbert’s fund buys lesser-known small- and mid-cap
European stocks that he believes are on the verge of faster earnings
growth because of a product break-through or a turnaround in their
business.

Leading performer Herbert has played a lot of small-cap European shares
to big gains this year while shorting giants Danone and Unilever. Photo: Chris Gloag for Barron’s

“Even
though Europe is mired in anemic growth, it really doesn’t matter
because our companies are innovating and actively selling their products
in China, Latin America, and the Middle East,” says Herbert, 42. “It’s
paradoxical that many of our companies are exhibiting organic growth
rates between 5% and 20%, when gross-domestic-product growth in Europe
is basically at zero.”

Herbert looks for companies that dominate
narrow global industries. Recent investments have included one in the
aluminum auto-engine-parts business and another in enterprise software
made specifically for banks. By his estimates—usually based on a
multiple of enterprise value divided by earnings before interest and
tax—his picks tend to trade at a 40% discount to their large-cap peers,
and their organic growth rate is four times as fast. He’s short a number
of big, household names.

The preference for small-caps has
evolved over time for Herbert, who was raised in the French-speaking
Swiss village of Cologny by an Israeli father and an American mother. He
first became interested in the group while working as a stockbroker at
Deutsche Bank and then at private bank Lombard Odier Darier Hentsch, in
Zurich. He realized risk-averse institutional investors weren’t fully
exploiting the opportunity.

“If you can capture that explosive
growth in terms of investing in the company at the right point in time,
and if the company is cheap enough that you have a margin of safety,
that is where the money is to be made,” says Herbert, who has a joint
master’s degree in economics and business administration from the
University of Lausanne.

His Camox fund (derived from the Latin
word for a breed of mountain goat native to the Swiss Alps) has posted
outstanding returns this year, rising 24.77% through Sept. 30, according
to fund tracker BarclayHedge. That is nearly six times the MSCI World
Index’s meager 4.33% return in the same period. Over three years, Camox
has returned 33.01% annualized, more than double the MSCI’s 16.80%
return.

The gains helped boost assets under management to $255
million (205 million euros) by early October, from just $7.6 million
when Herbert started with a single analyst in February 2008. Camox’s
management fee ranges from 1.5% to 1.7%, plus a performance fee of 17%
to 20%, depending on how long investors agree to lock up their money in
the fund. Minimum investment is $500,000.

“He does not fall in
love with stocks,” says Gilles Lambotte, a partner at Octogone Group, a
financial advisory in Geneva that has invested in Camox. “He gets in and
out with conviction.” In September, when euro-zone inflation fell to
its lowest level in five years, Herbert believed “the market was
slightly overvalued,” so he liquidated 25% of his portfolio. German
stocks fell by 16% in subsequent weeks, so Herbert used the cash he’d
raised to buy stocks.

Camox currently has 25 long positions and six shorts. Among the bullish bets are Software
(ticker: SOW.Germany). Herbert likes enterprise-software stocks because
the companies collect monthly “maintenance charges” from
customers—usually large companies that can’t risk a shutdown. In the
second quarter, Software suffered a surprising decline in sales at its
“middleware” unit, whose products tie together different databases.
Middleware, for instance, is what allows the computer systems of
law-enforcement agencies and airlines to work together to cross-check
passenger lists for terror suspects. The revenue shortfall caused the
stock to fall 33%.

But Herbert’s research found that the company
had lost a senior sales executive and spent a lot of time seeking
certification to work with the U.S. Defense Department, which hurt
European sales. He’s betting sales will rebound. Camox bought shares at
about €18 each, and by mid-November, the stock had risen to €21.50; he
has a target of €40 over two to three years.

Another favorite is Temenos Group
(TEMN.Switzerland) of Geneva, the largest producer of enterprise
software for banks outside of the U.S. As European banks regain their
footing—their solid scores on recent stress tests suggest as much—they
can again afford to upgrade their information-technology systems.
Foreseeing the banking rebound, Camox started buying the stock for about
16 Swiss francs ($16.64) in February 2012, right after it fell sharply.
Since then, Temenos has nearly tripled, recently trading at CHF33.40
($34.55); Herbert expects it to rise above CHF50.

By quizzing
European companies about their suppliers and competitors, Herbert
occasionally discovers companies scarcely covered by sell-side analysts.
One example is Montupet,
(MON.France), a manufacturer of aluminum components for car engines
that suffered in 2009 when General Motors went bankrupt and orders fell.
Herbert bought the stock in September 2013 for €22, anticipating a
recovery in U.S. auto sales and an increase in outsourcing by German car
makers. Backed by rising revenue and profits, the stock has nearly
tripled, to €64. It could top €100 in two or three years, he says.

Among Herbert’s six short positions are large-cap European consumer stocks, including yogurt maker Danone (BN.France), and food and home-products giant Unilever
(ULVR.UK). He thinks the shares of these dividend-paying, slow-growing
companies are overpriced—selling for more than 20 times
earnings—because European investors are scrambling for protection
against a recession.

Shorting large-caps raises cash for Herbert
to invest in smaller gems that are growing a lot faster. “As long as
Europe doesn’t slip into a prolonged recession, our companies will do
just fine—and prosper,” he says.

E-mail: editors@barrons.com





Best European Stock Bets