Standard Life Investments

Through the Lens

Small but Perfectly Formed

  • European smaller companies benefit from economic recovery
  • Improved credit conditions and low interest rates benefit the European real estate sector
  • Less coverage of small-caps presents greater mispricing opportunities

The expectation is that Europe will deliver above trend growth during 2015. ECB intervention has resulted in a number of tailwinds for Europe, notably a weaker euro and improved credit growth which have in turn supported exports and corporate earnings. The falling oil price and improved domestic consumption have provided a further boost. Smaller companies often perform well during times of economic recovery and currently provide attractive growth opportunities. To uncover these opportunities it is important to really look 'under the bonnet' during the research process and avoid the volatility risks associated with small-caps.

One area we have recently examined as part of our European small-cap research is listed real estate stocks. Improved macroeconomic conditions, easier access to credit and the 'lower for longer' interest rate environment should all be drivers for the sector. Long-term government bond yields in Europe have been particularly low in recent years which has also resulted in a significant yield margin between prime real estate and government bonds. This has been an important factor in driving capital flows into European real estate.

We recently met with German real estate investment manager Patrizia, which confirmed institutional investors seeking yield are increasingly viewing real estate favourably, particularly relative to fixed income. This is even more likely to be the case following the announcement of QE. Patrizia feel comfortable that a yield from real estate of 4.5% is achievable. Following our meeting, we believe that German industrial real estate is worthy of investigation, given yields are still relatively wide and rental growth is at an early stage of recovery in the cycle.

Another real estate business we recently analysed is UK-listed Hansteen. We have known the management team for over ten years, having invested in its previous quoted vehicle Ashtenne, which the team built up and sold successfully. Our interest in the company was rekindled following our recent visit to Augsburg to meet with Patrizia. Hansteen has circa 40% of its portfolio in German industrial properties, with the balance in UK and other Western European industrial properties. The management team has built an attractive portfolio during the downturn, with considerable self-help potential through reducing vacancy levels.

Although we have been encouraged by our analysis of both these companies, our aim is to create a diversified portfolio that seeks to enhance returns, is cognisant of volatility and is without a sector or thematic bias. Small-caps generally make fewer headlines. Although this results in less research coverage, in turn it can provide greater opportunities for inefficiencies or mispricing, which is at the heart of our philosophy and process.