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The European debate: active or passive?

Europe has pulled out of recession and market experts are optimistic on the prospects for equities, but many advisers still favour an active manager over blindly following the market in this region
August 22, 2013

Earlier this month it was reported that the eurozone economy grew by 0.3 per cent over the second quarter, marking the end of the longest recession since the formation of the monetary union. Other indicators also suggest improvement, so, according to some market participants, such as Alan Higgins, chief investment officer at private bank Coutts, this also means good prospects for European equities.

"Corporate earnings potential is improving hence our overweight position in European equities," he says. "Economic recovery has been reflected in second-quarter earnings, with more than half of European companies beating forecasts. The striking note from this round of earnings is the high number of companies highlighting stabilising business conditions, not just in northern Europe but also in the south. European market valuations remain attractive relative to global peers and we are focusing on cyclical sectors such as autos and financials (especially insurance), as these sectors tend to be well correlated to a European recovery."

This is a similar position to Barclays Wealth and Investment Management which is 'overweight' Europe ex UK equities in its tactical asset allocation model as they are "likely to outperform as euro worries and world trade stabilise, despite poor local growth".

Because of the problems in certain parts of Europe advisers have favoured active funds, as there is not only a need to pick good companies but also to avoid bad ones, and troubled countries and sectors. Active managers can take advantage of mid and small-cap opportunities, which may not be present in the indices that exchange traded funds (ETFs) track. And there are some excellent managers running European funds, so to a certain extent you are buying into stockpicking skills rather than taking a punt on Europe.

But if European markets are going to embark on an upward trajectory, should you now take advantage of lower-cost passive funds? Especially as some of the indices they track, such as MSCI Europe ex-UK, are heavily focused on northern Europe. But Azad Zangana, European economist at asset manager Schroders, points out that the European recovery remains uneven, as the core export orientated economies continue to lead the way, while the smaller peripheral economies continue to struggle in their implementation of austerity.

So we asked five market experts whether to go active or passive in Europe.

 

Ben Yearsley, head of investment research at investment platform Charles Stanley Direct

"Over the long term I am of the opinion that good active managers will outperform passive or index funds, so over longer periods I would back managers such as Richard Pease who runs Henderson European Special Situations (GB00B3W46246) or Alexander Darwall, manager of the Jupiter European fund. However if you are massively bullish on a short-term basis and you want market exposure, then a tracker fund or ETF may be appropriate. Look at the costs and how well the investment has tracked the index."

 

Kevin Gardner, chief investment officer, Europe, at Barclays Wealth and Investment Management

"Don't get too hung up on the domestic European backdrop, a tremendous amount of bad news has been priced in to allow both active and passive funds to outperform similar funds invested in the rest of the developed world."

 

Ben Gutteridge, fund analyst at Brewin Dolphin

"Typically an active manager can play the obvious trends, for example long Northern Europe, Scandinavian currencies and external revenues, and short consumption. That said, active managers currently doing well may not be the way to play the anticipated recovery and passive funds would give more absolute exposure to areas which may rally, such as cyclicals. We are including a bit more cyclical exposure but via an active fund - Neptune European Opportunities (GB0032308594). We recognise that European data are improving, but are still nervous about the political outlook."

Although Neptune European Opportunities has not performed well over the past few years, more recently it has been improving and the fund is now heavily invested in cyclical shares in sectors such as financials, industrials and autos (read our report on this).

 

Martin Bamford, managing director of chartered financial planners Informed Choice

"We still prefer actively managed funds in the European equities space. There is so much disparity between countries that only active management can give investors exposure to the regions with the best prospects."

 

Niamh Wylie, portfolio manager at Coutts

"Europe is a highly fragmented market with an abundance of under-researched medium and small-sized companies. This environment lends itself well to stockpickers with the expertise to exploit these opportunities. As markets transition from being stimulus-led to recovery-led, we're seeing wide divergences in performance of companies from the same industry.

"Active managers can also use the recent increase in volatility to their advantage by picking up quality companies at attractive prices. While passive investing tends to outperform when the market is rising as a whole, active management is a better option where direction is less certain, and has been shown to be more resilient in setbacks."

Active fund options include IC Top 100 Fund Jupiter European Opportunities Trust (JEO) which is the top performing fund in its sector over three and five years (read our tip). Henderson Eurotrust (HNE) is also a long-term strong performer (read our interview with manager Tim Stevenson).

On the open-ended side Mr Bamford suggests the unit trust version of Mr Darwall's trust, Jupiter European (GB0006664683). "This has delivered above-average returns over one, three and five years," says Mr Bamford. "Over the past five years, Jupiter European has returned 87.3 per cent compared to a sector average of +35.2 per cent. By way of comparison, the HSBC European Index Fund (GB0000469071) has a five year performance of 28.7 per cent.”

Other top long-term performers are BlackRock European Dynamic (GB0000495209) and Threadneedle European Select (GB0001529345), run by former Investors Chronicle journalist David Dudding.

Read our interview with Mr Dudding

But if you want to follow the markets at a lower cost, passive options include iShares EURO STOXX 50 UCITS ETF (SEUA) which has a total expense ratio (TER) of 0.35 per cent and tracks 50 of the largest stocks in the eurozone.

You could also consider iShares MSCI Europe ex-UK UCITS ETF (IEUX), which has a TER of 0.4 per cent and more than 60 per cent of its assets in northern Europe. Both use physical replication.

 

Read more on Europe ETFs

Read about the opportunities in European income

Also see our video debate on active versus passive funds