Greece's financial travails have been making headlines for several months now. Lately the economic woes of Portugal and a few other European nations--most notably Spain--have pushed them into the spotlight as well. Their bonds have fallen in value. The euro is suffering. Stock prices in many European markets are also feeling the pain.
Such overwhelmingly negative news often prompts canny investors to think of ways to benefit. To take the contrarian path. After all, you don't have to be Warren Buffett to know that juicy opportunities can arise when others are running for the exit.
But that doesn't mean you should rush to buy a Europe-stock fund. For one thing, most of the region's stock markets haven't fallen all that far, and the euro isn't even close to its historic low. Further declines are hardly out of the question. Second, even if you've decided the pessimism is overblown and are inclined to jump in, making such a play isn't a simple task. As with any other investment, it makes sense to investigate before buying.
The following is far from a comprehensive list of factors to consider. But if you're thinking of investing in a Europe fund as a contrarian move, here are a few things to keep in mind.
1. You may already have substantial exposure to the rest of Europe. Funds in the international large-cap categories tend to have notable weightings. BlackRock Global Equity, Fidelity WealthBuilder, First State Global Opportunities, Investec Global Equity, M&G Global Growth, and Newton International Growth--to name but a few--may be heavily weighted towards the US but at last check each one also had between 10% and 30% of their portfolio in European equity (including assets outside the eurozone).
2. By and large, Greek and Portuguese stocks play a very marginal role in international funds. That's true even for those funds that specifically target Europe. A quick scan through funds in the Morningstar Europe Ex-UK Large-Cap Equity category reveals very few that have even 1% of assets in either country. By contrast, Spain weightings in Europe-stock funds vary widely.
3. A continued fall in the euro will be a negative when Europe-stock fund returns are translated into sterling for UK-based shareholders, but a further decline in that currency wouldn't be all bad from an investor's perspective. Exports play a big role in the fortunes of many European companies, and a weak euro makes the goods and services of eurozone companies more attractive to potential buyers outside of that zone, just as we have witnessed in the UK of late with the weakened pound.
4. Don't assume that even an unhedged Europe-stock fund will provide full exposure to a potential euro rebound down the road. In fact, half the weighting of the MSCI Europe Index consists of countries that do not use the euro (the UK, Switzerland, Sweden, Denmark, and Norway). These other European currencies sometimes move more or less in line with the euro, but on occasion--as in 2010--there can be sharp differences.
5. If you're hoping to cash in on a rebound in the euro, don't buy a fund that hedges a large portion of its foreign-currency exposure. That helps returns for overseas shareholders when European currencies fall, but has the reverse effect when those currencies strengthen.
6. More-targeted plays are available in the exchange-traded arena, but those too have traits that render them less than ideal. For example, iShares/S&P Europe 350 focuses exclusively on the eurozone, but 72.3% of its assets are invested in the UK, France, Germany and Switzerland. Only 0.3% is in Greece, and 0.5% in Portugal.
7. The number of ETFs, closed-end funds, or managed funds devoted specifically to Portuguese or Greek equities can be counted on one hand. You can take a look for yourself using our Fund Screener tool.
8. Remember that the returns of the European-equity category provide only an imperfect indicator of how Europe is faring. Economic fortunes don't necessarily translate directly to investment returns.
9. Finally, the above points are aimed at investors thinking of investing in equity funds. But it's safe to say that trying to make a play on the fixed-income side also would involve numerous complexities--some of them very different from the ones cited here. So it would make sense to tread even more carefully in that realm.
Gregg Wolper is a senior fund analyst with Morningstar.com; Holly Cook is Editor of Morningstar.co.uk.
