Carmignac Absolute Return Europe: Letter from the Fund Managers

Over the first quarter of 2025, Carmignac Absolute Return Europe (A EUR Acc share class) realized a negative performance of -1.99%.

The beginning of 2025 has been a turbulent period for investors, as markets continuously recalibrated in response to geopolitical and macroeconomic events.

January commenced on a positive note, with significant inflows into European equities from global investors aiming to diversify away from the correctional markets in the US. A pivotal moment came with the German government's unexpected announcement of a €500 billion program to enhance defence and infrastructure. This initiative was widely regarded as a catalyst for European growth, anticipated to further bolster substantial inflows into European equities, especially in defence stocks and cyclical/infrastructure sectors. Consequently, European equities outperformed US equities during the quarter for the first time in many years with the Stoxx 600 outperforming the S&P500 by 10%.

US equities had experienced an exuberant rally following the election of President Trump, but soon faced potential headwinds and distortions due to the "America First" policies. Despite Trump being in office for only a few weeks, the growing uncertainty around the US government's policy agenda and its impact on economic data, coupled with frequent aggressive headlines from the administration, began to weigh on market sentiment, driving US markets into correctional territory. Concurrently, increasing skepticism about artificial intelligence (AI) and especially Data Centre expansion, prompted more cautious commentary from the industry, applying pressure on US tech stocks, including the “Magnificent 7”. This triggered a substantial de-grossing event among hedge funds. Quality stocks were generally sold off while shorts were aggressively covered, causing substantial pain for most investors and exacerbating the de-grossing. Additionally, the rapid spike in volatility severely impacted investors, impairing their ability to hedge portfolios, and thus further accelerating the market correction.

During the first two months of the quarter, European equities surged and managed to retain most of their gains, in contrast to US equities which entered negative territory. The top-performing sectors in Europe included Banks, driven by positive earnings revisions and accelerated buybacks and dividends, as well as Insurance, Telecoms, Utilities, and Construction. However, sectors such as Travel and Leisure, Media, Retail, and Autos lagged behind.

After a strong start to the year, the portfolio encountered significant challenges in February and March due to intense market rotational forces and unprecedented levels of de-grossing, which triggered heavy selling pressure. While the main positive contributors were Financials, particularly banks, and our industrial shorts, these gains were more than offset by losses in Technology (AI sell-off), Consumer Discretionary, and Healthcare.

In such unfavourable and unpredictable market conditions, we strived to remain as disciplined as possible within the fund's restrictions and rules to manage risk. Accordingly, we reduced long exposure in Industrials, Healthcare, Consumer Discretionary, Technology, and Materials—sectors potentially vulnerable to tariffs. Additionally, we added short positions in some cyclical European names which, in our view, had rallied excessively following the German stimulus program announcement. We also initiated short positions in European names likely to be impacted by a deteriorating US consumer environment and economy.

We reduced our gross exposure from a high of 130% in January to around 100%, and our net exposure from the mid-20s to 10-15% by the end of March, fluctuating daily based on our various option hedges. Despite our best efforts to protect the portfolio, it was frustrating to watch our January profits turn into a 2% loss by the end of the quarter due to the macroeconomic and geopolitical-induced sell-offs and rotations. The last few weeks of March were among the most challenging since the onset of Covid-19, characterized by unpredictable headlines and numerous policy reversals, primarily from the US administration. Unfortunately, these challenges have persisted into early April and have worsened since Trump's 'Liberation Day.'

Currently, the world is experiencing a period of unprecedented uncertainty. The tariff-based policy decisions introduced by the new US administration have embedded an element of 'Trump mania' into the global capital markets psyche, creating significant headline risk with dramatic consequences on a daily basis. There is a palpable risk of an all-out trade war, forcing business leaders, corporates, and investors to operate in a landscape with zero visibility, and we have yet to witness the economic ramifications in hard data and corporate earnings.

The Q1 reporting season is expected to be dominated by a loss of confidence in the earnings outlook for 2025. It would be almost surprising if management teams do not issue warnings about future prospects or significantly downplay their expectations. In these circumstances, our primary focus must be on capital preservation until this geopolitical turmoil subsides, while simultaneously retaining the ability to be reactive and opportunistic with the opportunities that will undoubtedly arise in the coming months.

Despite the greater level of uncertainty compared to previous crises, we know that they eventually come to an end. When they do, there will be incredible opportunities. For example, many of our fundamental positions, especially long ones, are now vastly oversold—even in a recession scenario, particularly within the healthcare sector—as they have suffered greatly from the widespread de-grossing. These positions should offer enormous upside potential once the geopolitical landscape stabilizes.