Foreword

Last summer's confidence crisis in Europe extended into Q4 2011 as financial markets continued to face uncertainty over the level of interest rates on sovereign debt and the growth potential of economies trying to slash debt. American and UK investors continued to show mistrust in the euro, shunning financial and cyclical stocks in particular. As a result, the companies we invested in last summer -- which in hindsight was a bit premature, even though they were already trading at low levels -- dropped to valuations that are completely disconnected from any plausible macro or micro-economic scenario (except a Eurozone meltdown).

Though the slow, cumbersome pace of decision making in Europe can be frustrating at times, real progress was made in December when the ECB agreed to supply European banks with unlimited liquidity up to three years. Although this eliminated a major risk (the collapse of the European banking system), it is still extremely risky this early in the new year to try to forecast the scope or duration of the European recession or the equilibrium level at which world growth will stabilise. Given the prevailing pessimism, Chinese growth is expected to slow down, yet without taking into account the moderating impact it would have on commodity prices, which in turn would bolster western economies. Under these conditions, it is also risky to try to project the speed at which the markets will return to "normal" valuation levels.

Consequently, we cannot exclude the possibility that the scepticism that prevailed in 2011 will extend into 2012. To skirt this situation as best we can, we have developed a two-pronged strategy that consists of focusing on 1) companies that offer intrinsic growth potential, irrespective of the level of overall macroeconomic growth, and 2) heavily discounted securities whose initial catching-up phase does not depend much on general market valuations.

Two positions we initiated this summer illustrate these two approaches: Ipsos and Peugeot. Ipsos provides research that helps companies understand their market environment, which is more vital than ever in these changing and uncertain times. The company is growing faster than its market, which in turn is growing faster than GDP and simultaneously smoothing its cyclical fluctuations. Real operating leverage will ensure vigorous earnings growth.
At the other extreme is Peugeot, which has been hit by the counter shocks of the general automobile markets in Europe. However, notwithstanding the fact that it reduces the effect of these shocks through a shift towards premium models and internationalisation, nothing justifies a valuation of 20% of net asset value or 50% of the value of current BRIC investments financed through cash flows, which create upside potential that is completely independent of the future PE level of the CAC 40.

Without excluding the importance of a market environment analysis, it is our understanding of companies and the selection of appropriate investments more than the economic cycle that will be the key to realizing the unusually high upside potential of our funds as 2012 gets underway.