10 Questions With Invesco European Fund Skippers Chamberlain and Chapman

(Editor's Note: This week's 10 Questions was published Tuesday instead of Monday, due to publishing problems.)

And you thought there were a lot of cell phones here.

Talk to enough growth-fund managers these days and you'll hear about plenty of go-go tech and telecom companies based in Europe, such as Nokia(NOK) and Ericsson(ERICY). Plenty of these stocks trade in the U.S. through ADRs, or American Depositary Receipts, and if you own a couple of growth funds they're probably already in your portfolio.

So, this week we're huddling with two guys who run one of the best European funds around: Steven Chamberlain and Marc Chapman, skippers of the (FEURX)Invesco European fund. Over the past five years, they've ridden tech and telecom stocks to outsize returns. These wireless communications bulls see European stocks rebounding from what has been a lackluster year so far.

Steven Chamberlain	Marc Chapman
Fund (FEURX)Invesco European Investors
Managing Fund Since Aug. 1, 1990 (Chamberlain)
Assets $900 million
YTD Return/Rank in Category 3.5% / 10 of 47
3-Year Return* /Rank in Category 25.9% / 5 of 33
Load / Annual Expenses None / 1.52%
Top Holdings Ericsson class B (Sweden) Vodafone Group (U.K.) TeleCity (U.K.)
Source: Lipper. Returns through Aug. 24. Holdings as of Aug. 21. * Annualized.

1. What have you seen from the European markets so far this year, and where do you see it heading?

Chamberlain: So far this year, returns generally in the marketplace as a whole have been fairly disappointing, with a slightly negative return in U.S. dollars. We've seen very good earnings development this year, but that has been offset by rising interest rates and also a lack of a lead from the U.S. stock markets.

However, we think that the outlook for certain stocks remains very dynamic. They are delivering very strong earnings growth, and when the market ceases to be too worried about the economic outlook, i.e., when we can see a more stable growth outlook and a peak in interest rates, we believe that investors will return to those good-quality stocks delivering strong earnings growth.

Our outlook remains fairly upbeat after what has so far been a bit of a volatile and lackluster year.

2. What industries and companies look attractive to you right now?

Chamberlain: Within the larger sector than companies we still think that some of the communications equipment companies are well-positioned. Companies like Ericsson, which has a U.S. ADR, are well-positioned to benefit from the growth of the mobile information society, which would be the convergence of mobile communications and the Internet.

The new subscribers and the launch of new, high-bandwidth services mean that the infrastructure will need to be very much strengthened and expanded. Ericsson as the world leader in that field will benefit more than most.

In other areas, we want to focus on companies that are benefiting from technological change, but maybe from a slightly different angle. Many of the companies in Europe are having to re-engineer their business processes in order to compete, to cut costs, and also to be able to move closer to that end customer.

In that regard, a lot have been logistics companies, and especially those that offer valued-added services will benefit.

3. What are some industries and companies that you think are a bit overvalued right now?

Chamberlain: I think from our perspective, within any sector, of course, some companies can do well but at the moment the defensive consumer noncyclical companies have been doing very well for the last three to four months. These are things like the health care sector, food, beverage and tobacco stocks -- the sort of things where you have seemingly clearer visibility on earnings and a price-to-earnings multiple that's today, those stocks in this environment have done well.

But we would be more cautious about investing broadly into that area. First of all, valuations are no longer particularly attractive, and secondly, many of them are still in low-growth businesses that are going to come under pressure from various areas. They are franchises we think will be diluted by technology, for example. So we'd be quite cautious on low-growth defensive consumer companies.

4. Are the U.S. markets and the European markets beginning to correlate a bit more than they have in the past? What kind of diversification does one achieve by putting some money in Europe?

Chamberlain: We think Europe offers U.S. investors a very attractive way to diversify their investments. The European marketplace today is home to some very exciting growth companies. Indeed, the universe of stocks in Europe is expanding rapidly because, really for the first time, we're seeing a new development in Europe, something that only started a couple of years ago, which is namely the fact that people are beginning to commercialize good business ideas very rapidly, and in so doing are creating some very good companies in short periods of time. They're creating a lot of value for shareholders.

And they're able to do so because they can now get access to financing, which they were not really able to do before, especially from venture capitalists for example. Venture capitalists themselves now have an outlet by listing these new companies on some of our new exchanges, such as the Neuer Markt in Germany.

Today there are over 450 companies that list on that exchange that were not listed three years ago. And they have a market cap of over $200 billion. It represents many of the new type companies that are now Europe's future, and not Europe's past.

Another important point: Structurally, a lot of European investors are underowned equities. Mutual-fund development, the mutual-fund market in Europe is much smaller than in the U.S., despite the fact that the European population is larger than the U.S. and there are many rich Europeans around.

We're seeing the increasing flow of money from European retail investors directly into stocks and also into mutual funds and we think that will run for a long time, and is a good underpinning.

In periods of high volatility, markets become even more correlative, and certainly within sectors you can get more correlation. But in periods of more stable performance, markets can diverge, and it would be possible, for example, for European markets to outperform the U.S. as they have been doing so far this year for that to continue. But when you see wild swings, I think you will always see all global markets, to some extent performing in line.

5. Are you seeing any bargains in the technology and telecommunications areas?

Chamberlain: In technology, we could probably put together a strong case that there are many European companies with equally strong growth prospects as some of the U.S. companies that are trading at lower valuation levels. And I believe that if Nokia, for example, had been a U.S. company with its track record that its multiple would certainly be higher than it is today.

It has a very strong track record of earnings growth, of good execution and high return on capital employed. Of course the stock in the last three months has come in for profit-taking, because there are lots of profits to be taken and because they do have a short-term issue on execution. However, we believe that they will come through that, the long-term fundamentals remain very much in place, which means that if that is the case, the company is trading around four to five times next year's earnings, which is roughly in line with or just a slight premium to its long-term growth rate.

Many U.S. companies that dominate their industry tend to have price earnings growth rates of at least two times. So on a U.S. comparable the company would probably be about 40% to 50% higher than what it is today if we were to compare it with other U.S. stocks.

And there are similar other examples throughout Europe. On technology, in terms of telecommunications, though the valuations have been higher in European companies for some time, among the telecom operators. But that's partly because they have much more exposure to mobile, which has been growing faster.

But today you could argue that the faster growth or the larger growth now is still to come in the U.S. But many of those companies are trading on, or some of those companies are trading on lower multiples than Europeans. The European telecom stocks we're not overly keen on at this point, although they've not been very good performers this year.

6. There's been a great deal of interest and volatility in the wireless sector. In terms of growth, do you think we are still in the early innings?

Chamberlain: Yes. The growth outlook remains extremely bullish for the wireless sector. At the end of this year, we'll see about another wireless penetration, globally, will be between 11% and 12%, so they will have added 4 to 5 percentage points global population this year. Next year could see an even larger increase than that.

At the moment, wireless penetration is still fairly low vs. wire line, especially so in the U.S. The European market's more advanced than that. The second thing within there actually is that use of a digital mobile handset is far more advanced in Europe. About 98% of European subscribers have a digital phone, but I think in the U.S., it's still only around 60%, if that. So the second thing is, you're going to see more replacements of older, analog handsets for digital handsets.

You will continue to see, we believe, migration of traditional voice telephony from fixed line to wire line. Today less than 10% of all phone calls that are made are made on a wireless device, and that will probably shift about 25% in the next five years.

You're going to get a lot more traffic on the wireless networks and that will be further boosted by new data services. So the outlook for European equipment manufacturers in that environment is very good. Ericsson, which has an ADR, is well-positioned to be the No.1 mobile infrastructure supplier in the world. And also Nokia, which also has an ADR, is also extremely well-positioned, they have a market share of 28% globally in handsets, and we believe in fourth quarter, with the launch of new models, that that could reach 35%, which means that they will be a dominant player in this industry.

And as we have seen in other industries, when companies have a dominant market share, they tend to have an even more dominant share of the profits. So 35% market share means that Nokia can generate margins in handsets over 20%, whereas the No.2 and the No.3 players will probably just have a high single-digit margin at best, and most of the others will lose money. So they will continue to grow in this marketplace longer term, and that's why we're still very optimistic about those companies.

I think the selloff earlier this summer on the Nokia results probably did get a bit overblown, but it was the first time for many quarters that the company had disappointed. Not with the second-quarter numbers themselves, but just with a caution about third quarter because of a few issues. But today it stands on multiples, which, we think, given its growth rate and given the fact that the fundamentals are still in place, makes it very attractive. We own shares.

7. What are your thoughts on Internet investing in Europe?

Chapman: I'll take that one. In terms of the Internet in general, we think most of the models are quite fragile.

We always thought most of the B2C, [business-to-consumer], models were weak and weren't represented in our funds, even when they were showing extremely good performance.

There will be plays for Internet growth in Europe with infrastructure providers, and one of them is called Telecity in the U.K. They host the servers of Internet service providers and corporations as a basic outsourcing model, so ISPs get bandwidth cheaper and they get maintenance cheaper. Telecity's gone 9 at the moment, it should have 20 by year end, and 42 by 2003. They've got a clear business model with clear revenue growth, profitability in 2002 and high long-term margins, which we think are a good way of playing the growth of the Internet, without having the competitive pressures of dot-coms.

8. What countries look strongest to you in terms of economic strength and solid growth? And what ones look a bit weaker in the near term?

Chamberlain: The weighting of countries in the fund, of course, is driven by our ability to find attractive investments there. But it must be said that Germany at the moment looks fairly good as an investment region. Economic growth has been accelerating there, core inflation remains very benign, and there's lots of excess capacity especially from a labor point of view, which today globally is a rare source.

So there are lots of very well-educated Germans that are still waiting to get a job. At the same time, you've got a government that's becoming much more friendly towards big business.

We've seen recently the passage of legislation to reduce corporate tax rates, capital gains taxes for corporations and also personal income taxes, and that is a sign of the increasing competition in Europe between governments to bolster their economies and support new businesses, which are creating jobs. So that's a good sign to see generally for Europe. Clearly, the Germans are ahead of some others within that game.

Also, they're not beginning to talk about pension reform in Germany, which is equally an important step from the European perspective.

Other countries that may be not addressing the issues quickly enough perhaps would still include the Italian market, which it still seems fairly lackluster in its economic growth, although it's improving.

But they don't seem to be making enough structural changes in the overall economy for us to get excited about Italy overall. Although we can always find some interesting companies, but there's a lot of reform needed in that marketplace.

9. If you had to pick three stocks you'd invest in today and hold for five years, what would those three be?

Chamberlain: One stock we've already talked about but that we would still call a favorite is Ericsson, which has an ADR. It has a potentially very large target market in which to grow and although it's the market leader, it can continue to take market share from here, and it's also a stock that in the past has had execution problems, particularly on handsets. But we think that that will, one way or another, that issue will be resolved. Though it is not trading at a premium over technology companies, but that may well happen as they execute on the mobile infrastructure site, which is the core of the company.

We very much like Ericsson, we think strong fundamentals are underpinning the market.

Another company would be Vestas Wind Systems, which I'll let Marc talk about this Danish company.

Chapman: We think it's attractive from a long-term growth point of view. It's the market leader in the manufacture of wind turbines. We think renewable energy is a good growth industry, because many governments are focusing on reducing their carbon dioxide emissions.

Vestas is the world market leader, with a 30% market share, an excellent industry reputation and a rapidly expanding market.

Chamberlain: The last one we would mention is Tomra Systems, the Norwegian company that is the world leader in reverse vending machines.

These are the machines that sit, either at the back of supermarkets or in parking lots, and they are where you take your used beverage containers, whether they be bottles, or tins or cans to get your deposit back. They have a 98% share in those machines in Europe and over 80% in the U.S.

Today their machines handle less than 2% of the beverage containers used globally per annum. It's a very good environmental play, because as people begin to reuse materials much more, this is by far the most efficient way of collecting used beverage containers, so potentially, this is already a market growing very fast -- i.e., 30%-40% per annum -- and we believe it can sustain that for a considerable length of time.

10. What is the last new stock added to the fund, and the last new stock added to your personal portfolio?

Chapman: In the fund, the last name we added was Synthes-Stratec. This is the European leader in the orthopedic trauma market. So it makes spinal cages and instruments to repair broken bones.

The market can only grow because of its demographics. The aging populations means osteoporosis is more common, the younger generation are more engaged in dangerous sports, leading to a market growth of 8%-10% globally. And they're the leader in Europe and they penetrate the U.S. market with between 50 and 60 new products each year. Their valuation is very attractive at the moment.

Chamberlain: In terms of personal investing, neither of us really participate in that. It's easier to own our funds, so that's what we do.

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