ChampionsNews: Mr Strobl, the German Mittelstand is often called the backbone of the German economy. Would you concur? Why are SMEs such a crucial investment for you? What makes them so particularly attractive?
Strobl: German SMEs are most certainly playing an important role for the broader German economy. The German Mittelstand consists of many highly competitive companies whose position is protected by high barriers to market entry or patents. Most are niche players with a focused business model, above-average return potential and great innovative strength. Some companies are market leaders in their industries, which enables them to achieve structural earnings independently of the economic cycle. Over the past years, SMEs have proven that they can generate significantly higher returns on equity and overall capital than your traditional blue chips. Stronger earnings growth and profitability are convincing arguments for investments in German SMEs.
ChampionsNews: According to which criteria do you select the right company for your portfolio?
Strobl: We typically start by evaluating the overall industry and the company’s competitive position with a focus on drivers like demand, industry momentum and market potential. At the company level, we look at barriers to market entry, market share, pricing power and margin potential. A crucial prerequisite for potential candidates is their financial situation. Solid balance sheets, sustainable cash flows and future investment ideas are important criteria. We also engage regularly in discussions with the management to determine in how far the official strategy is being implemented and to understand the incentive and ownership structures.
ChampionsNews: Your investment universe consists of German small caps. Why didn‘t you cast a wider, for instance European, net to increase diversification?
Strobl: The BERENBERG-1590-AKTIEN MITTELSTAND (DE000A14XN59 ) invests in shares of smaller and mid-sized companies from the German-speaking region with a market capitalisation of up to five billion euro and annual revenues of below three billion euro. Our stock selection focuses on the most attractive small caps that exhibit convincing structural growth, solid balance sheet characteristics and sustainable earnings. For investors seeking broader diversification, we also offer a small cap fund with a European focus: the Berenberg European Small Cap (LU1637619120 ).
Most are niche players with focused business modelsAndreas Strobl ,
fund manager Berenberg
ChampionsNews: Which investments have been most attractive recently?
Strobl: IT companies and industrials have the biggest weight in the portfolio and we added to our positions in recent months since this is where we continue to see the greatest growth opportunities. Having said that, our focus is less on individual sectors and more on the topic that will shape the German Mittelstand in the years to come: the digital transformation. This is a cross-sectoral issue that affects numerous companies and can be broken down into many sub-themes including digital media or digital integration. These areas should see continued structural growth going forward. Conversely, we recently sold telecommunication-related companies after their shares greatly benefited from sector consolidation in Germany.
ChampionsNews: The continuing low interest rate environment means that there is currently no alternative to equity investing. Do you expect a trend reversal for interest rates over the coming months? Should investors continue to focus on equities? And will small caps remain a sensible alternative to blue chips?
Strobl: The current economic readings as well as the stabilisation of the political environment in Europe make us optimistic that the economic recovery will continue in 2018. A potential regime shift by the European Central Bank should not meaningfully impact this scenario. While German SMEs have certainly benefited from the decline in interest rates over the last years, most companies also have solid balance sheets and strong cash flows and should therefore be relatively impervious to a slow rise in interest rates. The broader markets will very likely react to decisions by the ECB, though. On the whole, however, we remain bullish on the European equity market on the back of the continuing supportive economic environment and the strong earnings development across much of the corporate sector. German small caps are currently trading slightly above their historic averages. However they still appear attractive compared to their large cap equivalents – in recent years, the positive business outlook of SMEs was reflected in significantly stronger earnings growth versus large companies.
Author: Andreas Strobl and Timo Lüllau
Date of issue: 2/20/2018
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