Strong euro likely to determine where the best opportunities lie

As the strength of the euro troubles exporters, managers are switching from long-only towards short positions

Stock pickers will fare better than index followers among European long/short managers in the coming months, according to industry figures.

There will be increasing opportunities on the short side, with the strong euro defining where they can be found, they say.

An increasing appetite for restructuring and consolidation could also create investment opportunities for managers with the skills to find them.

"This will be a revealing year for European long/short managers," according to Anthony Gibson, fund manager of the $600m Coronation Global Equity Fund since 1996, when the fund was set up for the company's pension fund clients.

"It will be a great environment for skilled managers to differentiate themselves by adding value on both the long and the short sides," he says.

"The past two years have been a story of market direction. First we had the massive unwinding of equity holdings by European pension funds and then we had the very broad-based, liquidity-driven recovery from April last year. Going forward, it will more about adding alpha through stock picking, and this is something some hedge funds are very good at."

Fundamentally driven managers focused on stock picking will do well, he says, and they are likely to increase their gross exposures by adding more positions on both the long and the short sides.

"We are looking for managers with a proven track record of adding value on the short side," he says. "Managers who use indices for shorting will be less interesting.

"With the complexity of many corporate structures, sectoral pricing inefficiencies, the fragmentation of the existing universe and the return of an appetite for consolidation and restructuring, Europe will provide plenty of opportunities for skilled equity hedge fund managers. This is a market where we expect managers with solid experience, deep understanding of the underlying drivers and strong analytical skills to step up."

Paul Le Page from stockbrokers and hedge fund managers Collins Stewart, believes discretionary managers with low net exposure or black-box type models running equity-neutral strategies will perform well in Europe in the current environment.

There is also an improving climate for short sellers who do their research, he adds, despite many managers believing it to be a difficult environment for shorting.

Short sellers need to be able to identify genuine shorts based on performance expectations, says Le Page. One area they are looking at, due to the strong euro, is traditional European exporters who are losing out to Asian-based businesses, which have lower labour costs and weaker currencies.

Many managers are also looking at semi-conductor related businesses, because semi-conductors is a heavily leveraged and very cyclical business.

The European telecom sector is also fertile ground for short sellers, according to Le Page.

European long/short is becoming an increasingly interesting space as managers migrate from long-only, according to Kevin Boscher, a director at Collins Stewart.

More traditional long-only managers in Europe have managed to make a successful transition than in the US, he believes. "We have found US managers [to be] much more reticent to increase net long exposure and take on risk," he says.

European managers have been quicker to anticipate recovery and a tendency to be more generalist has worked in their favour, adds Boscher.

"The easy money has been made in terms of the index going up," he says. "However, we see plenty of opportunity through stock selection and sector rotation from here."

This is a transitional year for world markets, according to Boscher, which will see less liquidity and a rise in credit risk that could manifest itself in a major default.

Despite the risks, the current situation poses opportunities for managers who buy volatility, he says.

Energy is a good theme for managers on the long side. On the short book, European export sectors, including car manufacturers and some consumer luxury goods are faring badly because of the strength of the euro.

Very few European long/short managers are aggressively short, according to Boscher. "Even though the euro is a factor, they still see plenty of value in European stocks," he says.