Market themes

Europe’s earnings season could be categorised as reasonable in the context of currency strength and macro uncertainty. Europe’s autos and chemicals sectors faced a wave of profit warnings amid mounting geopolitical and macroeconomic pressures. Automakers including Mercedes*, BMW* and Renault* downgraded forecasts, citing rising US tariffs, weakened Asia Pacific demand and slowing global sales. In chemicals, BASF*, Covestro*, Fuchs* and Syensqo* cut earnings guidance due to soft industry demand, oversupply and energy cost inflation. These warnings underscore sustained margin pressure and sector-wide exposure to trade volatility and cyclical headwinds.

The French government called for a no-confidence vote on 8 September as the country’s authorities continue to struggle to deliver a credible budget. French government bonds and equities both sold off in August in response to the latest episode of the political drama. If it was outside the Eurozone, the French fiscal problems would likely have caused an acute government bond crisis, putting pressure on politicians to find a solution. The reality of being inside the Eurozone makes the situation more of a chronic problem, with insufficient external pressure to force resolution. We continue to think global businesses listed in France will not be materially affected by local country issues. Financial sector shares have generally responded positively to higher bond yields so far in 2025, but bond yields going up for the wrong reasons will surely become a problem at some point.

Markets went into clearly exuberant territory in September. The difference in sentiment between April and now is quite striking. Oracle rallied a remarkable 36% in one day on announcing a $300bn increase in its backlog related to OpenAI. OpenAI announced a new funding round that raised its implied valuation to $500bn. NVIDIA announced a $100bn investment in OpenAI. NVIDIA also announced it was taking a stake in Intel, following the US government announcing it would take a stake. It all feels very frothy and uncomfortably circular.

Q3 saw style dispersions between regions, with quality and growth outperforming in the US but underperforming in Europe. Europe is seen as lacking AI winning exposure but having AI losing companies. In fact, there has been a dramatic reappraisal for some European perceived AI winners to being potentially vulnerable (examples include exchanges like Deutsche Boerse*, SAP*, Relx* and Wolters Kluwer). It points to a highly speculative environment driven more by narratives than hard facts.

Q3 attribution

The Fund (GBP I Acc Share Class) was down -0.7% in Q3, underperforming its benchmark, the MSCI Daily Net Total Return Europe Ex UK Index, which returned 4.8% (both figures in sterling terms). 

The final month of the quarter was poor for our strategy despite no material single stock issues. While not owning ASML Holding* hurt relative performance (it has rallied just under 40% since the start of September), the majority of the Fund’s underperformance was style related. Attribution saw the Fund underperform in almost all sectors. We have had periods like this before (first half of 2018 and 2019-21) where lacking beta and momentum hurt relative performance across almost all sectors. It feels terrible in the moment even though you know it will reverse. We take heart from how quickly we recovered relative performance in Q4 2018 and 2022 when markets on both occasions reverted to more balanced conditions of risk-taking.

Good companies at reasonable valuations steadily underperforming are a compelling opportunity

Good companies at reasonable valuations steadily underperforming are a compelling opportunity for those able to take a medium-term time horizon. Selling good companies in 2018-20 for excessive valuations was ultimately the right decision as they derated after 2021. It felt very uncomfortable at the time. Similarly, buying derated quality over the past 18 months has felt similarly uncomfortable in the face of poor near-term price momentum. There have been long periods over the past five years where cautious investors like ourselves have felt like the designated driver at the biggest party since the TMT bubble. We remain of the view that income funds will perform strongly when the current euphoria ends. 2022 gave a taster of this but was arrested by the excitement around the ChatGPT release in November 2022.

We have learnt the lessons of our underperformance in the 2019-21 period of style headwinds. The mantra has been ‘keeping up as best we can’ when our style is out of favour. We have been quicker to sell stocks that are not performing well and running our winners a little longer. We have avoided stodgy defensives that offer secure dividend yield but little else, such as Nestlé*. We have stopped buying genuine small caps below a €5bn market cap after analysing Inalytics. 

We are confident that our investment process is more robust than in the period when it steadily outperformed between 2011 and 2018, we just need more balanced markets to reveal this progress. We felt we had done a reasonable job of keeping up in the first three months of the post-Liberation Day rally. Having done a great deal of analysis of tariffs in late 2024 and early 2025, we steadily added ideas we felt had sold off too much rather than moving more defensive. However, we feel the rally morphed into excessive risk-taking in Q3. We remain constructive on our portfolio given its quality characteristics and compelling valuations.

Top relative contributors

• Not owning SAP (software): the company highlighted that uncertainty around trade policies and tariffs appears to be prolonging sales cycles in specific areas, promoting management to proactively position themselves for a less favourable environment.
• Tele2 (telco): Tele2 delivered strong Q2 2025 results, raised full-year guidance and robust EBITDA growth driven by cost efficiencies and disciplined execution.
• Industria de Diseño Textil (Inditex; retailer): Inditex outperformed due to strong early autumn/winter sales growth, resilient H1 2025 results and disciplined cost management. Its agile supply chain, balanced online/offline model and ability to quickly adapt to consumer trends continue to drive market share gains.
• Not owning Nestlé (staples): Nestlé’s weak performance was driven by a combination of modest revenue growth, margin pressure from steep commodity costs (especially cocoa), foreign exchange drag and governance changes damaging confidence.
• Pernod Ricard (spirits): having sold the position in July, shares remain weak as the company continues to face sharp declines in China (especially cognac sales) and US market weakness (amid tariff and inventory headwinds) as well as a collapse in travel retail sales.

Top relative detractors

• Edenred (payment solutions): Edenred has underperformed due to regulatory pressure, as a new antitrust enquiry into alleged collusion in Turkey adds to reviews in France and Brazil.
• IMCD (chemicals distributor): the company acknowledged that demand softened in Q2, particularly in more cyclical / industrial segments, which weighed on conversion.
• Not owning ASML Holding (semiconductors): ASML Holding’s shares have risen on the back of robust demand for advanced chipmaking tools, driven by the global AI and semiconductor boom. Share buybacks and analyst upgrades have further supported sentiment, despite cautious guidance and ongoing export control and valuation risks.
• Carlsberg (brewer): despite raising the lower end of its full-year operating profit guidance, management flagged that consumer spending is unlikely to improve in the back half of 2025 as inflation, uncertainty and weaker retail conditions weigh on discretionary consumption.
• Novo Nordisk (pharma): the company slashed its 2025 sales growth guidance to 8-14% (from 13-21%) and trimmed its operating profit growth forecast to 10-16% (from 16-24%), after signalling slower momentum in its flagship products (e.g. Wegovy; Ozempic).

Portfolio highlights

There are often developments in stocks that are more meaningful to our medium-term investment time horizon but may not be market-moving enough to show up in quarterly attribution reports. The purpose of this section is to share some of these portfolio developments that we find encouraging.

• Coloplast: Coloplast unveiled its strategic plan at its capital markets day, targeting 7-8% organic CAGR over the next five years amid a more complex global environment, while maintaining ambitions to outperform market growth through innovation, customer-centricity and operational excellence. The company is restructuring into Chronic Care and Acute Care units to sharpen focus, drive efficiency and leverage digitalisation and AI. Coloplast aims to lift ROIC above 20% by 2030, uphold a 1.5x leverage ratio and resume share buybacks, reflecting disciplined capital allocation. Its new global operations plan (GOP7) focuses on asset optimisation, digital transformation and cost efficiency, supported by a diversified manufacturing footprint in Europe and Latin America. Segment highlights included strong momentum in interventional urology with next-generation implants and overactive bladder solutions; expansion in Chronic Care, especially in the US and emerging markets; and Wound Care growth driven by Kerecis’ clinically proven fish skin technology.
• Iberdrola: management presented its 2025-28 strategic plan, reinforcing a predictable, profitable and secure growth trajectory anchored in regulated and long-term contracted businesses, with net investments of €50bn. Around two-thirds of spending will go to networks, mainly in the UK and US (65%), reflecting its focus on A-rated countries and stable regulatory frameworks. The networks business is set to deliver double-digit growth, with the regulated asset base rising to 40% (€70bn by 2028), while renewables will see selected investment. The group targets EBITDA of €18bn by 2028, with adjusted net profit up to €7.6bn (high single-digit CAGR) and 75% of EBITDA from regulated or long-term contracted activities. Management also reaffirmed a 65-75% payout ratio, a dividend per share floor of €0.64, and no need for equity issuance this decade, leveraging strong cashflow, asset rotation and partnerships. We think this positions Iberdrola as a resilient and value-creating leader in the accelerating energy transition.
• TotalEnergies: The company reaffirmed its strategy as a differentiated, profitably growing multi-energy company, targeting 4% annual energy production growth through 2030 across its dual pillars of oil and gas and integrated power. The group plans to maintain strong capital discipline, streamlining net capex to $15-17bn per year while achieving $7.5bn in cash savings (2026-30) and keeping gearing below 20%. Supported by low cost, low emissions upstream portfolio and expansion in liquefied natural gas, TotalEnergies aims for 20% annual growth in free cashflow per year through 2030 at $70/barrel Brent, enabling payouts above 40% with a growing dividend and flexible buybacks. Integrated Power is set to deliver over 100TWh of generation by 2030, focusing on deregulated markets (US, Europe and Brazil) and contributing to resilient cashflow beyond oil and gas cycles. The company remains committed to reducing Scope 1+2 emissions by 50% from 2015 levels by 2030, achieving -25% lifecycle carbon intensity.
• Conference takeaways: We attended a generalist and several sector-specific conferences covering industrials, TMT and utilities. At the German corporate conference, companies had highlighted modest but resilient Eurozone growth, German fiscal stimulus in defence and infrastructure, persistent trade frictions with the US and ongoing structural weakness in China.

The message from the industrials conference was one of relatively narrow excitement around AI-related themes like data centres, but caution around areas like the automotive sector, China and US residential property activity (if no significant interest rate cuts). 

European telecoms struck a notably bullish tone

At the TMT conference, Publicis Groupe presented a reassuring picture of execution against clearly strategically weaker advertising agency peers. Meetings across European telecoms struck a notably bullish tone, with Tele2, Koninklijke KPN (KPN) and Orange all expressing confidence in sustained earnings growth, structural efficiencies and clear execution visibility. Tele2 highlighted EBITDA expansion through cost discipline, network optimisation and broadband opportunities. KPN reiterated pricing power and stable shareholder returns via share buybacks. Meanwhile Orange emphasised cost transformations, fibre migration and upside from European consolidation alongside robust growth in Africa and the Middle East. 

The utilities conference highlighted the sector balancing heavy capex with regulatory uncertainty and surging power demand from electrification and data centres. Redeia* warned that Spain’s draft rules – lower returns; revenue cuts; weak work-in-progress remuneration – threaten profitability and investment despite doubling grid spend. Enel stood out with disciplined capex, opportunistic M&A, stable Italian regulation and buybacks underpinned by conservative leverage. E.ON* guided confidently to 2025-28 but German regulatory mechanics and subsidy design remains swing risks.

Fund activity

We continued to exit fully valued positions and performance detractors in Q3 with the sales of Zurich Insurance Group (Zurich), Munich Re, Pernod Ricard, Sanofi and E.ON (explained in more detail below). On the buy side, we have been looking to use the now material underperformance of high-quality stocks since their 2021 peak to selectively buy what we see as good companies at now compelling valuations. As a result of the reset of quality valuations, we are seeing the best fund opportunity set since at least 2018. As a reminder, in early 2019 the Fed pivot prompted many of these stocks to rerate to absurdly high valuations that made their subsequent poor performance inevitable.

Sells

• We sold two insurance positions in Zurich Insurance Group and Munich Re after strong performance as we believe much of the upside is now priced in. Zurich is trading at its highest ever earnings multiple, leaving little headroom, while Munich Re’s high-quality execution and capital discipline are already reflected in its share price. With the property and casualty insurance cycle showing early signs of softening, we see a less supportive underwriting environment ahead. We continue to like non-life insurance and reinsurance on a long-term view but feel more comfortable with lower sector exposure into a softening pricing cycle.
• We chose to exit drinks company Pernod Ricard due to a deterioration in its underlying fundamentals since our initial investment. Both the US and Chinese markets – key profit centres – remain weak, with little visibility for a meaningful recovery in 2026. Additionally, rising tariff exposure is likely to weigh on margins, compounding near-term pressures.
• We sold our position in pharmaceuticals company Sanofi due to a combination of factors that, in our view, made the risk/reward increasingly unattractive. It has become less obvious whether Sanofi represents value or a value trap. The pharmaceuticals sector is behaving less defensively because of US risk factors. In addition, progress on Sanofi’s pipeline drugs has been underwhelming.
• We sold our holding in E.ON (energy grid). While we continue to like regulated power grid assets, the 40%+ year-to-date rally has made it a much less compelling dividend stock given the long-term need to finance grid capex. We also feel there is less margin for error in the stock at this valuation with some risk that regulators continue to disappoint in upcoming regulatory review periods. It seems that regulators might not allow the generous returns on new grid investments the market is expecting.

Buys

• We started a position in Enel, an Italy-based utility. We believe the company presents an attractive opportunity, offering strong value at a forward P/E of 11.6x and a 4% free cashflow yield. The company’s 6.1% dividend yield is well supported by a stable earnings base – 90% of EBITDA is derived from regulated or long-term contracted activities –ensuring high visibility and resilience. Enel is actively shifting its portfolio towards low volatility regulated grids and contracted renewables while reducing exposure to emerging markets, enhancing cashflow predictability and derisking execution. Backed by a disciplined €43bn capex plan focused on brownfield renewables and network upgrades, the company is positioned for steady earnings growth and strong capital returns. With a structurally improved balance sheet, robust liquidity and a proven commitment to shareholder remuneration, we see scope for double-digit total shareholder returns in the near term.
• We initiated a position in Inditex, the Spanish owner of Zara and other clothing brands, based on its compelling valuation, operational excellence and long-term growth potential. Despite recent underperformance driven by weather and macroeconomic factors, the stock trades at an attractive 20x FY26e P/E, below its 10-year average of 22x, with a strong free cashflow yield (4%) and dividend yield (3.9%). Inditex’s innovation-led model – anchored by Zara – offers unmatched speed to market, high return on capital (30%) and a track record of profitable growth. Over 25% of group sales are now online, and its €5.4bn capex programme is reinforcing its leadership in logistics and technology. With 50% near-shore production, Inditex responds rapidly to fashion trends, supporting full-price sales and minimal markdowns. Its global footprint, especially the underpenetrated US market, provides a structural growth runway. Backed by a net cash position of over€10bn, strong ESG credentials and a focus on premiumisation and operational efficiency, we believe the company is well positioned to deliver sustainable long-term returns.
• We initiated a position in Wolters Kluwer, a well-managed and cash-generative business with a highly defensive earnings profile and long-term structural growth drivers. The company is benefiting from secular trends such as rising regulatory complexity, evolving tax codes and increasing demand for corporate performance, ESG, financial compliance and tax and accounting solutions. With 84% of revenue recurring through digital and subscription services, the company enjoys best-in-class resilience, complemented by leading positions in Clinical Solutions and Tax, and a growing shift toward expert solutions. Its strong execution track record, consistent margin delivery, and disciplined capital allocation provide further support, with scope for excess cash returns to shareholders. In addition, the company is well positioned to leverage AI to enhance its product suite and deepen customer integration. While not inexpensive at 19.8x 2026 P/E and a 5.3%free cashflow yield, we view the valuation as increasingly attractive given the quality and durability of its growth.

Outlook

We have a positive outlook for European equities. We see external threats to the region as finally prompting meaningful policy changes in the region. These include more pragmatic fiscal, competition and green policies. The starting valuation of European equities and our view of the likely improved earnings outlook over the medium term drive our constructive view.

We currently like cheap defensive sectors and selected quality stocks that have derated

Within the market, we are cautious about deep-value, low-quality stocks, especially those exposed to trade tariff risks. Areas of the market that we currently like include cheap defensive sectors and selected quality stocks that have derated. We see both these parts of the market as unwarranted discounts driven by rising bond yields, not bottom-up growth prospects.

We continue to emphasise the importance of evaluating both valuation and cyclical risks. It seems an environment that will challenge both overvalued high-quality stocks and low-quality cyclical stocks. We expect a higher cost of capital environment will favour our core skills in valuation discipline and risk management.

* not held

08 October 2025