Europe recovery draws in investors

But some fund managers are now seeking to rein in this enthusiasm

WHILE the Eurozone has been plagued by macroeconomic and political uncertainty over the past few years, the case for investing in Europe may be strengthening. European bourses have performed strongly this year, boosted by news that the Eurozone returned to growth in the second quarter, and signs that accommodative monetary policy may be loosened further. And according to Hargreaves Lansdown, European funds were among the top performers in October. So should you increase your exposure?

SURGING POPULARITY
According to Martin Skanberg of Schroders, Europe is increasingly being viewed as “the last of the value equity trades”. Peter Sleep of Seven Investment Management agrees. “At 14 times 2013 earnings estimates, the European market may not look too different from the US. But US corporate profits are at a record high, whereas European earnings are about 30 per cent below their 2007 peak, and have plenty of room to grow.”

Price, however, is only one reason for Europe’s growing popularity. Risks of a Eurozone break up have receded considerably. And Europe has a number of strong global brands, which are financially robust and in a position to benefit from international growth, irrespective of ongoing structural issues in the region.

Nonetheless, Jason Hollands of BestInvest advises caution. He is concerned the markets may be “a little overconfident” about future policy direction, so favours core European funds with a bias towards global businesses that happen to be domiciled in Europe. He points to the Henderson European Focus fund, which has yielded 30.72 per cent over 12 months, as one good option.

And Ian Hewett, portfolio manager at Aberdeen Asset Management, says his team is trying to rein in enthusiasm. “We get weary when valuations run ahead of where earnings are heading. There’s a lot of debt at government and individual levels in many European countries. There are still imbalances between the North and peripheral countries. These issues have been pushed to the back of people’s minds, but they haven’t been resolved. So we would recommend shorter-term caution.” He favours stronger corporates that have long-benefited from Europe’s skill capital, strong legal structures, good corporate governance, and protection of intellectual property.

ON THE HUNT FOR RETURNS
To reduce risk, investors in Europe have been willing to pay a premium for perceived safe havens. Food and beverage stocks, in particular, have seen a surge in popularity. But Skanberg says they are beginning to fail to deliver on their expectations, so investors may need to turn their attention elsewhere. He lists the telecommunications sector, among others, as a good alternative. “It has suffered a torrid time amid intense competition, too much debt, and dividend cuts. However, the intensity of some of these issues is starting to fade.”

BlackRock’s Andreas Zoellinger, meanwhile, thinks there is a turning point in sight for banks. He highlights Nordea, a solid Norwegian bank which has exposure to a resilient Nordic region. Swiss banks Credit Suisse and UBS have also delivered good returns this year.

Sleep, on the other hand, is not enthused by high-income, quality or blue chip stocks. “They outperformed in spades over the last three to four years, and may be due a breather.” He says small and mid-sized value companies are most geared to any recovery in GDP growth.

Rather than picking individual stocks – an investment approach best left to sophisticated investors with time on their hands – he suggests a number of trackers that are offering good value, like the Lyxor MSCI Equity Value ETF. Ben Smaje of Kennedy Black Wealth Management, meanwhile, points to the Vanguard FTSE Developed Europe ex-UK Index fund, with a total expense ratio of 0.25 per cent – “versus 0.4 per cent for the corresponding iShares ETF”.

THE BEST STRATEGY
There are a number of other approaches, however. Investing through a mutual fund is a safe option for the more cautious investor – the Fidelity Worldwide Fund, for example, has 30 per cent of its assets invested in Europe, with holdings including UBS, Volkswagen and French food company Danone. In 2012, Liberum analysts cited ARM Holdings, Vodafone Group and Sage Group as FTSE 100 companies with particular exposure to Europe, so investors could play the cyclical improvement in the Eurozone through an overweight position in UK equities. According to Jeremy Thomas of Allianz, who gave a recent webinar on the subject, it is easier to consider Europe including the UK for a global portfolio.

The question, of course, remains whether the European economic recovery is sustainable. The Eurozone crisis has not really gone away; tail risks like a high debt-to-GDP ratio remain. “The financial and economic positions of countries like Greece, Portugal and Ireland remain dire, banks still look undercapitalised, GDP growth is fragile, and estimated corporate earnings for 2013 and 2014 are still falling, which is hardly ever a good sign for stocks,” says Sleep. Investors must remain cautious.