Carmignac Absolute Return Europe: Letter from the Fund Managers

Over the fourth quarter of 2024, Carmignac Absolute Return Europe (A EUR Acc share class) realized a positive performance of +0.64%.

The fourth quarter was challenging for investors, marked by a volatile performance in European equity markets driven by macroeconomic and geopolitical factors. Initially, the quarter began steadily, but political uncertainty and rising bond yields in developed markets triggered a sharp rotation and selloff in October, resulting in a 3% decline in European equities for the month. This was followed by a rally in the US equity market, fuelled by optimism over Trump's election victory and anticipated tax cuts, deregulation, and other stimulatory measures. However, Europe lagged behind the US due to concerns over the potential negative impact of Trump's trade policies and tariffs on the European economy.

In December, the early rally in the US market reversed due to profit-taking, higher bond yields, and a shift in the Federal Reserve's (FED) messaging. Despite lower short-term interest rates in developed markets during Q4, the rise in US 10-year Treasury yields from 3.78% to 4.57% caused rotational volatility and negatively affected equity markets.

Overall, European equities declined by 2.9% for the quarter. Only the Travel & Leisure, Financials, Media, and Insurance sectors posted positive returns, while all other sectors were in the red. The worst-performing sectors were Real Estate, Chemicals, Basic Materials, and Healthcare.

Against that backdrop, we are pleased to be able to report a positive return for the quarter due to a combination of positive long /short stock picking and disciplined risk management. Against a backdrop of volatility and general uncertainty we maintained a relatively low gross of either side of 100% for the quarter and a beta adjusted net dynamically flexed between 10% and 30%.

Our biggest positive contributions came from Financials, Consumer Discretionary, Healthcare and Communications on the long side. Our short book made a positive return across the board with the largest contributions coming from Consumer stocks, Materials, Healthcare and Technology stock shorts. In addition positive contributions came from our futures and put option hedges, which helped to offset some lagging long positions in the Technology, Industrials, Real Estate and Utilities sectors.

As always, we endeavoured to take advantage of market gyrations to take profits and add shorts where required on strength and to buy mispriced assets on weakness. In terms of portfolio adjustments, the key sectoral moves were to temporarily reduce Technology, Utilities and Staples exposure over the quarter and add to Financials, long duration Industrials and Healthcare, particularly after the selloff. The short book required diligent management to lock in profits on dips and as shares fell to hit our price targets. As always, we tend to trade our short book more frequently as stocks fall in anticipation to then reestablish those positions once again as markets rally.

As we enter 2025, numerous unpredictable variables loom, including the impact of Trump's presidency and the uncertainty surrounding inflation and rate cuts. Central bank actions will be data-dependent, reminding us of the inaccurate market predictions at the start of 2024.

We believe this will be a year to remain committed to long-term investment themes while also being agile and tactical. We aim to maintain a balanced outlook and investment horizon, anticipating that European equities will continue to present significant opportunities for both our long and short positions.

In Q1, we plan to capitalize on the year-end volatility, when mean reversion often leads to recoveries in last year’s losing sectors or stocks, while previous winners underperform. These temporary shifts create opportunities for both our long and short positions. However, our stock selection will primarily hinge on corporate earnings outlook, with immediate focus on FY24 results and forward guidance.

While the fund possesses significant geographic flexibility, which we aim to leverage when optimal opportunities arise, our primary focus will remain on Europe. As we continue to argue, this is a great ‘hunting’ ground for our opportunistic and style agnostic, long/short strategy.

As we approach 2025, we see significant potential for our Long book to diversify beyond our usual global structural winners. Sentiment towards European equities is currently at a low point, with positioning remaining minimal following another year of EU equity outflows. This scenario presents a compelling opportunity, particularly if conditions start to improve. Historically, global investors tend to focus on Europe when valuations are exceptionally low or when there is a shift in the narrative. We believe now is an opportune moment to capitalize on this potential shift.

Potential catalyst for a more positive European outlook into 2025;

• The European Central Bank (ECB) will continue to cut rates more aggressively than the FED to stimulate the economy.
• The mew German government with a mandate for increased fiscal spending to boost investments in EU’s largest economy.
• A weakening of the euro and sterling, against the strong USD will support pan-EU overseas earnings.
• Confirmation of Trump tariffs could reduce uncertainty, enabling corporates to plan and invest, and allowing the market to progress.
• This clarity might lead to a rebound in EU manufacturing PMIs from weak levels, narrowing the gap with EU service PMIs, which have been held back by paused corporate activity.
• Likelihood of seeing net tariffs on EU goods being lower than proposed due to various industry exemptions and mitigating factors, for example if EU agrees to buy more gas/LNG from the US.
• Finally, if we see the first steps towards a resolution between Ukraine – Russia, it will not only improve sentiment but should open the way for falling energy prices and the prospects of rebuilding Ukraine, which will be very stimulative to the economy.

In summary, we see several potential positive catalysts for EU value and cyclicality, which could quickly improve the outlook for European equities, especially given the current low investor exposure. We are selectively adding risk, both tactically and on structural themes that we believe will benefit in the coming months.

We maintain our barbell approach with structural Longs in Electrification, Healthcare, EU Banks, Communication, and Technology. Our short book remains focused on late-cycle Industrials, Transport, and selective Consumer Discretionary names. Additionally, we are now incorporating shorter cyclical, deep value names that we expect to benefit from the anticipated positive shifts.