The European equity landscape makes for compelling analysis. There are political issues, economic inferences, security complications and fundamental considerations that would need a detailed thesis to comprehensively address. Yet, one of the most effective ways to uncover the opportunity on the continent is to apply a basic timeline of European equities relative to the rest of the world.
In doing so, the challenges on the continent quickly become obvious – with as much as 30% underperformance relative to global equities since 2015 and closer to 65% underperformance since the peak of the financial crisis in 2008. Driving this has been a plethora of worries, as it wasn’t that long ago that we were questioning whether the European Union could actually fall apart.
Fast-forward to today and the European trade may even seem alluring – with a combination of low prices, strong corporate earnings growth and some of the best economic conditions in a decade. In fact, Europe earnings growth is running at an annual growth rate of 18.7% to the end of March, far in excess of the 3.4% average annual fall in the decade prior. Even dividends are increasing at a faster rate, with 3.9% growth in dividends-per-share.
So, the fundamental landscape is changing. Yet, not all sectors and countries are benefitting – which is where the active management argument becomes interesting. Despite being a developed market with strong coverage, arguably making it more efficiently priced, the continent is still extremely fragmented.
For instance, European telecommunication companies are down 11.7% over the past three-years to the end of March, whilst French equities have increased by 22.1%. Hence, sector and country dispersion are important levers for active managers to pull in their ambition to maximise returns and/or minimise risk. The same goes for size, where small caps have significantly outperformed their large equivalents.
Bringing this together, the market reality is still incredibly complex. In the long-term – the period most investors should care about – investors need to determine whether they want a broad market-cap weighted exposure, or to select individual opportunities within the European landscape.
Regarding the latter, Morningstar Investment Management provides a useful lead to this discussion. This comes in the form of “valuation-implied return expectations” that tells us how much one could expect to earn from underlying opportunities on the assumption that prices return to their fundamental baseline over a 10-year period.
Based on Morningstar Investment Management’s most recent analysis, the biggest opportunities reside within unloved areas such as European telecommunications and Italian equities, eclipsing the more popular areas such as German and French equities. The UK is also one of the favoured markets. By numbers, the return expectation is closer to 4.6% per year for stocks in the FTSE 100 versus just 3% for European equities in aggregate.
By extension, emerging Europe may also have distinct appeal as it is expected to deliver 4.5% per year and is often disregarded by investors. To access such an opportunity, it is important to pick a high conviction fund that is benchmark agnostic. The key is not to be afraid to allocate a dedicated position to a country or regional fund, especially when disparity in valuations is apparent.
With little benchmark constraints, Brandes European Value Fund goes its own way. This Silver-rated fund is often packed with unpopular stocks and has a larger exposure to small- and mid-caps than most peers. Sector weightings can also vary greatly depending on opportunities--energy and consumer staples are currently overweight. The fund also ventures into Eastern Europe and Russia, as high as 10% historically. The fund therefore carries high risks as 2017 was a painful reminder. But overall, this seasoned five-person investment team has done a good job historically at navigating ups and downs.
Low-cost exchange-traded funds that track country indexes are obvious choices for targeted country exposure, but they are market-cap-weighted and often have quite sizable positions in individual names, which means they favour the same blue chips that investors may already own through broader regional strategies.
Many country indexes do not fully represent the opportunity set that is available to active managers. Truly active single-country managers can build deep expertise in their respective home markets, enabling them to look for hidden gems that will likely be under the radar of blue-chip-oriented funds. For this reason, most of our highly rated single country funds will tend to be active strategies.
3 Top Performing European Funds
Fidelity European Dynamic Growth: We believe the fund is a strong and distinctive option for European large caps. Fabio Riccelli took over the fund in November 2008. His consistent execution of the unconstrained, growth-tilted process and Fidelity’s research edge have been key to the fund’s success. It carries a Morningstar Analyst Rating of Silver.
Jupiter European Growth Fund: Alexander Darwall has managed the fund since April 2007. The fund is unconstrained to allow him to find the best opportunities across Europe. Darwall has delivered excellent returns for investors whilst not taking excess levels of risk. The fund receives our highest Analyst Rating of Gold.
M&G Pan European Select Fund: John William Olsen took over this fund in July 2014, having joined M&G earlier that year from Danske Capital. He built strong track records there on global and European strategies. Our conviction in the robust investment process, and the level of detail in the team’s research has continued to grow. We have therefore upgraded the fund’s Morningstar Analyst Rating to Silver from Bronze in February 2018.
A version of this article appeared in Portfolio Adviser magazine
