The Big Theme
Europe has been a no-go area for many investors because of the financial crisis, and before that a perception that it offered no growth or dividends. However, in recent weeks, increasing numbers of professional investors and advisers have warmed to Europe, with low valuations being a key attraction. Although the troubles are not over, the region is showing signs of steady improvement, according to Tim Stevenson, manager of Henderson EuroTrust. Because of this, he is prepared to increase the trust's debt to top up holdings during market dips.
"Equity valuations across Europe are similar to those three decades ago and yet companies are now far better managed," says Mr Stevenson. "There are plenty of quality companies, led by reliable management, that are financially stronger than most European governments and which are rewarding shareholders. What's more, payout ratios are on the up and those that had not previously issued a dividend are starting to. We have seen a pick up in international investor interest in Europe of late, but more important still has been a noticeable increase in the participation of the domestic investor, a trend we believe will be sustained for years not just months. We cannot wait until Europe returns to a more normal situation; we need to take advantage of its new reality and find companies that can flourish in this low-growth world. We need to start viewing the situation in Europe as an opportunity, not a threat."
It is not only Europe managers who are enthusiastic. A recent survey by fund research company S&P Capital IQ reported that two-thirds of global funds they surveyed were overweight in European equities (read more on this). Richard Oldfield, who runs the SJP High Octane Trust, a global equities fund, is overweight Europe ex UK, his largest geographic exposure, although he doesn't allocate according to geography, but rather according to companies’ merits. "We are seeing very good companies in Europe at the moment, and they are as cheap as they have been for a long time," he explains.
Peter Hewitt, manager of the F&C Managed Portfolio (FMPI) fund of investment trusts, which invests globally, recently told Investors Chronicle: "I would not be surprised if European markets do quite well in the next year or two. They are the one part of developed markets that is cheap." (read the full comment).
"Stocks look cheap on two key metrics: the equity-risk premium relative to bonds, and also compared with their longer-term price earnings (PE) trends," adds Jason Hollands, managing director at investment adviser. Bestinvest. "The art of equity investing is to buy things when they are cheap and sell when they are high."
While it is good to pick up things cheaply, there are still many problems in the eurozone. European shares were priced for extremely dislocating events such as the break up of the eurozone, according to Ashish Misra, head of investments at Lloyds TSB Private Bank, although he feels that the risk of these has receded significantly. "Strong policy intervention by the European Central Bank has reduced the risk of any extreme events that would negatively affect the European equity markets and raised the probability of a more stable median-case scenario," he says.
Although the price-to-book ratio of European shares has recently risen from around 1.1 times to around 1.5 times, this is still below their average long-term trends. "In terms of their price, European equities are now trading at just over 30 per cent discount in terms of price-to-book value ratios relative to US equities," adds Mr Misra. "This trend of relative underperformance - now nearly two years old - has likely grown a little long in the tooth and does raise the possibility of a period in which European equities outperform their US counterparts."
It's also not just about price - investors are getting excited about European shares because they include some of the world's most successful multinationals.
UK investors have good reason to allocate to Europe because different markets have different industry characteristics. The UK has a very high weighting to financials and oil and gas, whereas in European equity markets you find many luxury brands and pharmaceutical companies. "So investing in Europe is a way of providing industry diversification to a portfolio as much as it provides geographic diversification," says Mr Hollands.
Although many companies look good, the many problems remaining in the eurozone could create market volatility. A Greek exit or broader meltdown for the euro would have implications for European equity markets, although almost certainly for stock markets outside the eurozone as well.
The fundamental issues behind the crisis remain and some eurozone countries need to bring down their levels of debt, which could take a long time. Austerity measures are likely to affect European growth rates.
However, European companies' earnings are not necessarily related to the countries where they are listed. "For example, Unilever generates 55 per cent of its revenues in emerging markets and recently disclosed it had generated €1bn (£800m) in revenues from selling Magnum ice creams to the Chinese," says Mr Hollands. "Similarly, BMW recently reported sales growth up 14 per cent in September, despite shrinking business in Europe."
But this means some exporters could suffer if there is a slowdown in China and emerging markets. Earnings reports are likely to spark some volatility on the markets if profits come in below forecast and guidance is weaker than expected, according to Cedric de Fonclare, manager of the Jupiter European Special Situations Fund. "When European firms gave out their guidance earlier this year, many of them were factoring in an economic recovery in Asia, particularly in China in the second half," he says.
BEST FUNDS FOR EUROPE EXPOSURE:
If you invest in Europe for value you should have a long-term investment horizon and a high-risk appetite. How much you should allocate will depend on your duration, risk profile and goals, according to Mr Hollands. "For example, in our growth moderate risk model, we allocate 64 per cent to equities, of which 12 per cent would be to European equities, for a strategic, longer-term allocation.
One of the best active Europe funds is IC Top 100 Fund Jupiter European Opportunities Trust (JEO) (read our tip). Its share price and net asset value (NAV) total return has remained well ahead of its peers and the index over one, three and five years. However, this, together with renewed interest in Europe, means it has moved to a premium to NAV of around 1.5 per cent. The trust's manager, Alex Darwall, also runs a unit trust, Jupiter European (ISIN: (GB0006664683), also a top performer. However, the unit trust has a total expense ratio of 1.79 per cent against 1.19 per cent for the trust, and a slight premium can be worth paying for strong outperformance.
Henderson Eurotrust (HNE) has not done as well as Jupiter European Opportunities, but beats the benchmark and most of its other peers over three and five years. It can be picked up on a discount to NAV of more than 9 per cent. This trust targets large and medium-sized companies wthat are perceived to be undervalued in view of their growth prospects or on account of significant changes in management or structure, and manager Tim Stevenson favours quality consistent shares, which he holds for the long term.
Investment trust details
|Trust||Discount/premium to NAV (%)||1-year return (%)||3-year return (%)||5-year return (%)||Ongoing charge (%)|
|Jupiter European Opportunities||+1.54||48.44||105.53||58.42||1.19|
Share price cumulative performance data as at 2 November 2012
Among unit trusts and open-ended investment companies (Oeics), one of the top performers over one, three and five years is IC Top 100 Fund Threadneedle European Select (ISIN: GB0001529345) - read our tip. The fund's manager, David Dudding, targets companies with a competitive advantage, high-quality defensible earnings and consistent growth rates and, although the approach is growth-orientated, factors such as brand loyalty or pricing power are also important.
For a more aggressively-traded portfolio, Jason Hollands, managing director at investment adviser Bestinvest, suggests BlackRock European Dynamic (ISIN:GB0000495209), the top-performing fund over five years, and among the top five over one and three years. The fund has a high-conviction approach, holding only between 35 and 65 stocks, and the flexibility to invest in large, mid or small-sized companies.
There are also a number of passive exchange traded funds (ETFs) tracking Europe that could be a cheap and quick way into the market if you believe it will continue to rise. These include our recent tip iShares MSCI Europe (read the tip), which includes exposure to the UK. For pure European ETFs, read our our analysis of the best choices here.
However, in uncertain markets such as Europe, there is an argument for an active manager as above who has stacked up positive returns despite ongoing problems. "Passive funds make sense in some markets at certain points in the cycle. But, given our view that we want to target global brands and stay shy of domestically-focused stocks, we don't think this is the right approach for accessing European equities at this point," says Mr Hollands.
Europe open-ended fund details
|Fund||1-year return (%)||3-year return (%)||5-year return (%)||Total expense ratio (%)|
|BlackRock European Dynamic||22.47||31.64||42.38||1.68|
|Threadneedle European Select||19.70||42.51||25.89||1.69|
Cumulative total returns as at 2 November 2012
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