Funds to ride the European rally

In dire straits for much of 2022, European equities have enjoyed an aggressive bounceback so far this year. The FTSE Europe ex UK index was up by nearly 11 per cent year to date as April neared its end, notably outpacing sterling total returns of 5.9 per cent for the FTSE All Share, 5 per cent for the MSCI World and 3.9 per cent for the S&P 500.

That might turn heads, especially after such a disconcerting 2022 for a region that often finds itself out of favour among investors. The Ukraine war and spiralling energy prices put a dampener on the region’s prospects last year, but much of the situation appears to have turned around. As BofA investment strategists Sebastian Raedler and Thomas Pearce recently noted: “Equities tend to move in line with current growth momentum and the recent macro data has continued to come in strong, with euro area purchasing managers’ indices (PMIs) rising to an 11-month high in April.” They note that gas prices have plummeted, while companies in the region have benefited from China’s reopening, given their focus on exports to the world's second-largest economy.

And yet the risks of a false dawn are real enough. Raedler and Pearce maintain a dim view of the region, arguing that boosts from falling gas prices and China’s reopening should fade away, while other developments can cause problems.

“We think a sharp loss of growth momentum remains the most likely continuation of the story,” they said. “The typical transmission lag of monetary policy suggests that the full growth impact from the aggressive central bank tightening campaign is set to materialise by Q4, while most of the recent support factors for growth are set to fade or have already faded.” They added that they expect a “sharp weakening in growth momentum to translate into wider risk premia and accelerating EPS downgrades”, something that could spell bad news for European indices and could lead to cyclical shares underperforming more defensive shares.

Like some other regions, Europe’s economy has continued to hold up better than some might fear, if not performing convincingly well. Eurozone gross domestic product (GDP) rose by a modest 0.1 per cent in the first quarter of this year, missing expectations of 0.2 per cent but skirting recession fears nonetheless. As Gam investment director Charles Hepworth put it: “While this is not great, it is certainly not as bad as the previous quarter [when growth was zero]”.

With weak demographics and a long history of political and economic crises, Europe tends to be far from top of the list when it comes to regional allocations. But it does still come with many globally minded companies, from luxury brands such as LVMH (FR:MC) to semiconductor component maker ASML (NL:ASML). Plenty of funds serve as a way to access these, although they vary notably by style and process.

The funds

Having a bias towards quality companies, and those focused on growth, is one way to access companies with a promising narrative in a region known for its ups and downs, and multiple funds tend to lean in this direction. Matthew Bird, of Falco Financial Planning, singles out Jupiter European (GB00B5STJW84) on this front, noting: “It has been a long-running favourite of mine and notably has some great top holdings that tick quality and growth boxes, but possibly not value”.

Some of the top holdings are relatively familiar, from LVMH and ASML to pharmaceutical company Novo Nordisk (DK:NOVO.B) and Relx (Real), the UK-listed analytics specialist. The fund’s managers look for some of the classic metrics favoured by quality and growth investors, aiming to find cash-generative businesses that have clear barriers to entry and “visible growth opportunities”. The team looks to buy and hold such names for the long term. The first quarter saw them initiate a position in Richemont (CH:CFR), an owner of luxury watch and jewellery brands, while adding to positions in names such as  FinecoBank (IT:FBK). “We think Richemont offers significant pricing power, a portfolio of attractive brands and an increasingly focused business model,” the managers noted in a Q1 commentary.

It’s worth noting that the manager once closely associated with Jupiter’s European equity funds, Alexander Darwall, still runs the European Opportunities Investment Trust (EOT), which also focuses on businesses that appear to have good structural growth stories. While somewhat tarnished by Darwall’s significant previous backing for Wirecard, the trust still serves as a highly concentrated play on such names: it had a 14.1 per cent allocation to Novo Nordisk at the end of March, with 9.7 per cent in Relx, a similar amount in Experian (EXPN) and 8.7 per cent in Dassault Systemes (FR:DSY). The trust’s shares have had a somewhat lumpy performance in recent years in part due to the Wirecard implosion, and they recently traded at a 13 per cent discount to portfolio net asset value (NAV).

Some European equity portfolios do have a degree of UK exposure, which can lead to doubling up in terms of private investors' own asset allocation. European Opportunities recently had around a third of its portfolios in UK-listed companies.

Other options

Value funds are certainly also an option for fans of European equities. Tom Sparke, investment manager at GDIM, points to River & Mercantile European (GB00BMX64N98) as a high-conviction portfolio with a value element. It recently had reasonably large allocations to the materials and industrials sectors, with names such as healthcare business Roche (CH:ROG) among its top holdings.

The fund has a nuanced approach when it comes to investment style and the type of company it might back, from recovery plays to asset-backed companies and quality and growth. Lightman European (GB00BGPFJN79), by contrast, has a more explicit value bias, something that saw it perform strongly in 2022 but struggle so far this year. The investment team predicted in a March commentary that company earnings should slow as the cost of capital rises, noting: "We view the best protection in this environment is from equities with high free cash flow yields and strong balance sheets that operate in supply-constrained industries." Recent major holdings include Novartis (CH:NOVN) and Telefonica (SP:TEF).

Elsewhere, a popular fund that run into performance issues in 2022 is BlackRock European Dynamic (GB00B5W2QB11). One of the names in last year's IC Top 50 Funds list, specialists have tended to favour the fund not only for its normal record of good returns but also for its well-resourced team and for an approach that is both flexible and high-conviction. Not wedded to a particular style or sector, the fund targets companies that seem undervalued or have good growth potential. It allocates a chunky amount of capital to its top bets, with an 8.6 per cent position in Novo Nordisk, 8 per cent in LVMH and 6.9 per cent in ASML at the end of March.