Euro investors must remain cautious

But the region could offer good returns

THE CASE for investing in the Eurozone appears to be getting stronger. Many analysts still warn that the region is not out of the woods just yet, but some aspects of the macro-economic picture – the second quarter GDP release for the region showed growth (of 0.3 per cent) for the first time since late-2011 – may look promising.

Most diversified portfolios will contain some exposure to Europe, but clients investing through Hargreaves Lansdown Vantage only hold an average of 5.13 per cent in European funds. “Europe is not popular with UK investors,” says the firm’s senior investment manager Adrian Lowcock. “But European markets have performed well over the past 12 months.” The FTSE Europe Ex UK index returned 36.03 per cent year on year to July 2013, compared to 16.55 per cent for the FTSE All Share.

Some investors expect further progress to support the peripheral economies after the German elections this September, but Fidelity’s Trevor Greetham is sceptical. “The lack of fiscal stimulus in the Eurozone periphery is likely to mean political risk and sub-par economic growth for years. And we are particularly concerned about the lack of progress on banking union,” he says.

And growth in the Eurozone in the second quarter was largely driven by its two largest economies: Germany and France. The Spanish and Cypriot economies contracted by 0.1 and 1.4 per cent respectively. The Greek economy, meanwhile, contracted at the worrying pace of 4.6 per cent.

Of further concern is that Eurozone equities are not as cheap as they were 12 months ago, but Lowcock is confident they still offer good value. “Investors are able to access strong global brands, which are financially robust and in a position to benefit from growth anywhere in the world,” he says. Europe is home to over 130 Fortune 500 companies, from ING Group in the Netherlands to Volkswagen, headquartered in Wolfsburg, Germany.

Investors have three routes to gaining exposure to European equities. The more sophisticated investor may choose to pick individual stocks, although this strategy involves significant time, research and expertise. One alternative is to invest through a fund. Jason Hollands of BestInvest points to the Threadneedle European Select Fund – which “provides exposure to quality companies in the region”.

But a cheaper option may be investing in a tracker fund. The Vanguard FTSE Developed Europe fund, for example, has an annual 0.25 per cent management charge, and is currently yielding 2.6 per cent. The downside is that, even if you match the market, the small fee incurred by tracker or passive vehicles mean you could under-perform relatively.

Alan Higgins of Coutts, meanwhile, points to potential in the auto and telecoms sectors. “Both producers and suppliers in the auto sector have begun to see improved business conditions, with European car registrations rebounding from a 20-year low. And the telecom sector is starting to see mergers and acquisitions activity,” he says. On the other hand, companies with large emerging-market exposure have seen poor performance, “as China has reduced spending on industry and energy”.

And Greetham prefers to play the cyclical improvement in the Eurozone through an overweight position in UK equities. “The UK is benefiting from a domestic housing-driven recovery, and it will benefit through exports if there is a continued pick-up in European growth – without the political problems that Europe has.”

Lowcock thinks some of this risk can be mitigated by making small, regular payments rather than lump sums, as well as having equal portfolio exposure to the UK, US, Eurozone and emerging markets. “The average investor should aim to have around 10 per cent invested in each market – or 5 per cent in emerging markets if they have a low risk tolerance,” he says. But whether European equities will offer the best returns in the longer term remains to be seen.