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November 7, 2005 12:37 pm

Melchior: European Opportunities fund

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James Hordern, manager of the Melchior European Opportunities fund, sees rich pickings in small and mid-cap European stocks.

A swathe of redundancies among the brokers covering this sector has reduced the accuracy of earnings forecasts, and the sector is “under-researched, under-valued and under-owned”, Mr Hordern believes.

The Melchior fund, part of the Dalton Strategic Partnership empire, was established in November 2003 and now holds 75 stocks in a portfolio valued at $220m.

It focuses on companies in sectors that are undergoing structural change, or those with a dominant position in a market niche.

Dignity, the UK funeral directors, meets the bill with a steady revenue stream that is relatively insensitive to economic developments. Organic growth is backed by an acquisition programme that brings in two to three companies a year on valuations lower than Dignity’s.

Tallin Water – “another dominant franchise” – looks set to benefit from rising prosperity in Estonia. As householders install washing machines and bathrooms, water demand is expected to increase, says Mr Hordern.

Switzerland’s Unilabs, meanwhile, is Europe’s largest operator of clinical laboratories, carrying out blood tests and other procedures. It is expanding outside its home market and expects to profit from deregulation of the French market, where previously, limits were imposed on the movement of samples between labs.

By drawing on the expertise of Dalton investment managers elsewhere in the world, regional fund managers can spot themes that are occurring in sectors globally.

Melchior has invested in Opera, a Norwegian company, after noting the interest being shown by Japanese mobile telephone companies in web browser technology.

The Melchior approach starts from the bottom up. From the 3,000 European companies with a market capitalisation of $100m to $5bn, a shortlist of 300 that meets its specific investment criteria has been selected.

“We look for companies with high returns on equity and capital employed, strong free cash flow and healthy or improving balance sheets,” says Mr Hordern.

“If you can find all those things at the same price as the market, then either the shares will go up or the company will get taken over.”

Eleven of Melchior’s investee companies have been bought since the fund was launched.

Melchior is an “unconstrained” fund that does not seek to match a benchmark, but it has risen 49.03 per cent since launch compared with a 40.95 per cent rise of the MSCI Pan-European Index. But over the past six, three and one month periods to end September it has slightly undershot the index.

Mr Hordern says the characteristics of the companies in which Melchior is invested should provide strong future growth.

He calculates that the average upside achievable from the portfolio to December 2006 is 31 per cent.

“With some we will get it wrong, which could reduce the upside to 25 or 20 per cent, but historically this approach has worked well.”

Charles Batchelor

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