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What is the outlook for the European market, as the war in Ukraine rages on? How will rising interest rates impact these assets? This episode, David Lambert, Senior Portfolio Manager, European Equities, RBC Global Asset Management (UK) Limited, weighs in. David also explains how he manages portfolios from an ESG perspective. [17 minutes, 00 seconds] (Recorded March 23, 2022)


Hello and welcome to The Download. I'm your host, Dave Richardson, and I'm really pleased to be joined today by my good friend David Lambert, who has recently been named Head of European Equities at RBC Global Asset Management. Dave, first of all, congratulations! It couldn't happen to a better guy. Someone who absolutely has a great background, incredible track record in terms of managing money. I couldn't be happier for you. So, congratulations!

Thanks, Dave. You know, these things are always bittersweet because the reason I'm becoming head is because the retirement of Dominic and we worked together for fifteen years and we've worked very closely and got on very well. So, these things are a two-edged sword. But I'm really pleased. I'm excited to be taking up the role and it's exciting times ahead.

Of course, Dominic has been a regular guest on the podcast. He is retiring, and we're going to miss him because he's one of our favorite guests as well. He always had interesting stuff to talk about in his professorial manner, as he is very sophisticated, Dominic is. But you've been side by side with him for the last fifteen years. You've been doing this together. I can't think of a more seamless transition. Throughout careers and through businesses, you want to have the right succession plan in place. You want it to just be a seamless shift. I can't think of a better example of that than this.

Well, thanks, because it's something we thought of long and hard over the years. I think it's important going through the team, going forward from now. But we've tried to do this slowly. This day was always going to come. So, it's something we thought about. It's really important. It's important in the businesses we invest in. When we apply this to companies that we invest in, we should be doing it ourselves. We thought long and hard about the way this was going to work.

Now as we get you on as a regular guest, we're going to get into what you and I both love, which is eating. The only thing is, as I've gotten older, I eat and get larger. You eat and get smaller because you're looking pretty sharp. It's too bad, this is just an audio podcast. This is one where I'd love to have the video on you, but we'll get into some of your great eating recommendations. But I think what's much more on people's minds right now is Europe and European equities, which again, you're now overseeing, and some of the challenges in the European market. We talked about with Dominic, and with Sarah Riopelle, who's been on the broadcast, who manages portfolio solutions, and thinking about where she's going to overweight or underweight positions. She tends to focus more on value and growth at a reasonable price where there's growth. When she was looking around just a couple of months ago at the World and where valuations sit in markets, Europe looked very attractive and particularly relative to the U.S. But of course, in the interim, we've had this horrific Russian invasion of Ukraine. Awful visuals, more and more every day, just a human catastrophe. Let's not lose sight of that. But from an investment perspective, it certainly changed the view of Europe, at least in the short term, when we look out at the world. But from your perspective, has it made that big a difference, or is this something that you think markets are going to look through as we get more and more into that invasion, or even with the potential of a ceasefire somewhere down the road, we hope?

I think ultimately the market will look over the valley and put this into perspective. But immediately, the first reaction is, the proximity of Europe to the events that are going on needs to up the risk premium to a degree. So, by default, what Sarah was implying, I completely agree with: there is a heightened level of risk within Europe. But then when we step back from that and we look what's happening on the corporate side, when we look at corporate earnings, corporate operational momentum, everything remains pretty robust. We have to remember that, although these companies are of European domicile, they're generally global in nature. They've got the ability to deploy capital all over the globe. Although the events are on the doorstep as such, the corporates are not impacted as much as one would think when you read the headlines. But, Dave, this is something we've experienced in European equities for many years. We've talked about debt crises, migrant crises, financial crises, particularly in Southern Europe. When we come and we speak to Canadian investors or investors anywhere, we try to disassociate European politics, European economies with European corporates. It's different. They are different beasts. The European corporates themselves are actually generally in rude health. Debt levels are lower. Debt has been financed further out. There's more duration in the debt book than is there. Free cash flow yields are really still attractive. From an operational perspective, we feel relatively relaxed. Now, notwithstanding that, the longevity of what's going on ultimately can start to impact, as we've already seen, inflation, commodity prices, supply chains, and these are what all corporates around the world have to juggle with. But we haven't seen any large lasting impacts so far. Just going back to the first point you made in terms of Europe looking value versus the U.S. on a multi-year basis. Yeah, I agree with that. But the counterargument to that is, it has for a long time. So when does that change? There are differences between Europe and the U.S. in particular. The makeup of the markets is very different. U.S. is very tech heavy. Europe, more financials dominated, and there's a tension there. Sometimes you can look at Europe versus the U.S. as U.S. tech versus European banks. It's not as simple as that, obviously, but that's when you look at the market level. Obviously, what we do is we invest in portfolios, not at the market level, in the best companies we can find. Again, you're not looking at the European economy, you're looking at European stocks, and then you're not looking at all the European stocks, you're looking at the best companies within Europe that we have. And that's what we focus our investments on, and we continue to do so.

Yes, and that's such an important point in terms of that company focus or almost bottom up as opposed to top down. Obviously, top down is significant, the environment that these companies are working in. But as you suggest, these are global enterprises. These are enormous companies. Sometimes in Canada we forget how long some of these companies have been around, how long some of these brands have been around, and how big and broad these businesses are on a global level. At the core, though, maybe go back and just as you're taking over as the lead from Dominic, and we haven't really reviewed it, what are the types of companies that you focus on? What is really the key behind your investment approach as you look at European companies?

That's the crux of it, Dave. Ultimately, we want to invest in the best companies, the best businesses we can find. The way we think about that is, companies that can generate higher returns, high levels of profitability on their asset base, generate enough cash and keep reinvesting in their asset base to grow. Generally, these companies are capital light. It doesn't cost a lot to grow. These higher returns can be recycled into the business and generate higher returns on the enlarged asset base. As you roll that up, over years and years, you get this beautiful compound in an exponential curve of shareholder value creation. That's exactly what we're trying to harness within the portfolio on a stock-by-stock level. It's interesting because obviously we do look at the top down, as you mentioned, but the top down is far less predictable. We cannot forecast at all with any certainty, and it's impossible, the direction of geopolitics. But what we can do from a bottom-up perspective, which is where our bread and butter is and what we're good at, we can make much better predictions on the profitability, the growth profile, the margins, the asset turnover, asset intensity of a business that's been around for two hundred years and had rock solid profitability through two world wars, etc. You know, what we're seeing into context? That's where we focus on, the area of the market where we have much more confidence and much more foresight. Then we focus on companies that have higher, sustainable, predictable, consistent, repeatable business models that churn out the returns year after year. That's the essence of what we're doing. That hasn't changed. When Dominic first arrived in 2007 and we first started working together, we harnessed the process and let the philosophy and process that we've embedded in, in everything we do, evolve, and this is continuing. It's a continuation of the evolution that's been put into place as of fifteen-odd years ago.

David, if we look at the U.S. markets, we've been seeing over the last several months that shift away from tech, which had led the U.S. markets for a number of years, back to some areas that really haven't been particularly of interest to investors for a long time: energies, materials, the old boring stuff that you dig out of the ground or build things, steel, aluminum. Are you seeing similar shifts in terms of the market leadership in Europe as well, and does Europe have some of those opportunities as we look forward if this shift persists?

The one thing I would say, if you look at them on a global context, the value region of the globe is probably Europe because of the high level of financials. There's still a lot of energy there and mining. That is the value bucket. We have seen that shift in leadership. I think what's driven it— and probably other people on your podcast have said a similar thing— is that the rapid rise in rates that we saw around the turn of the year, when we see these rapid rises in rates, you start to see dislocations within the market and you start to see rotations. Now, we've looked at studies over many years, and the rapidity of rate rises we find is far more important than the rate rises themselves. A nice steady glide path to higher rates don't tend to cause these dislocations, as I've already said, that we've seen so far this year. But big inflation spikes, big rate changes, and then people start to question the duration aspect of tech, for instance, in the U.S. Now, clearly, Europe is less exposed to tech, although tech is a growing sector within Europe. But we have definitely seen a shift to energy and quite rightly so, to be honest, Dave, because energy stocks have really been the dog's bodies. They've been beaten down. No one wants to know them, be it for ESG reasons or be it for capital intensive reasons. I think we've always been proud in the thought that we're flexible and pliable to not discount these big corporates, even though they don't fit the DNA of what I described earlier as what makes a great business. But when you get good businesses that are actually becoming less capital intensive, you're seeing less money pumped into exploration and production, and then you get an oil price that goes up. All of a sudden, you've got big beasts that create a huge amount of cash flow and are at ridiculous valuation. As investors, we have to be cognizant that even the companies that don't really look like and smell like a good company to us can be good investments. For instance, even though energies had a big run, it's still a really interesting area of the market that I think has been overlooked for far too long.

And then at the core— and you've operated in this environment in Europe, which is further ahead than North America around ESG—, all of this is done through that lens, is that not right?

100%. I mean, ESG is another asset. It's an intangible asset within a business that can help the level of returns, the sustainability of returns, the sustainability of your business going forwards. The aspects of ESG have become a little bit commoditized in the way people report about it, but for us, ESG really is about engagement, about pushing forward positive change, about keeping management honest. I think that's really important because as an active investor, that's exactly what we should be doing. Are they doing what they say they're doing? With respect to any ESG commitments, are they doing and are they executing on exactly what they're setting out? It's been a fundamental part of the way we look at investments for a long time. Over the last few years, it's just garnered the ESG label. Governance and the impact on environment and the impact of stakeholders in the business, the impact on society, on building things better, has always been very important. It's just now got this label and we're framing it in that context, but it’s vitally important because I think our clients want us to be doing that, but also, we want the corporates to be doing it, and we're there to hold them to what they say.

It's another tool to find a great, well-managed company. You and Dominic have done that. You've been ahead of the curve on that, and I have no doubt that's going to continue. Dave, again, congratulations. Great catching up with you. Great to see you. Again, we're audio here, but we tape with a video system so we can see each other. You look fantastic and you're just ready to go, aren't you?

The pandemic has treated you well, Dave. You look ten years younger than when I last saw you in the flesh, so something's been going right for you.

But it's exciting to have you at the helm, and we're going to miss Dominic. But as everyone can hear, if you are someone who invests in European equities or you want to have European equity exposure in Canada, you're in great hands with David Lambert. Dave, thanks, and we'll talk to you maybe in about two to three months and check in on how things are going.

Thanks, Dave. Thanks for having me.


Recorded: March 23, 2022

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