Investment committee: Should asset allocators be looking at Europe?

Chairman Beth Brearley, Editor, Fund Strategy 

In 2016 sentiment towards the European market was close to its lowest level since 2011-2012, with €100bn pulled from active European equity funds.

However, recent data shows the economic backdrop looks positive, with early estimates from Eurostat suggesting Eurozone GDP growth grew to 0.5 per cent quarter-on-quarter in Q4 2016, compared to 0.4 per cent growth in the previous quarter.

But event risk remains prevalent; Dutch voters head to the polls on 15 March to vote for the House of Representatives, with the populist Freedom Party currently in the lead. The following month, the French elections begin.

Presidential candidate Marine Le Pen has announced she plans to hold a referendum on EU membership and take France out of the Eurozone if she wins.

A recent survey by Sentix shows the number of investors who think France will leave the Eurozone is at an all-time high at 8.4 per cent, up from the 5.7 per cent in January. Meanwhile over a quarter of Sentix investors predict at least one country will leave the Eurozone this year.

Investor sentiment towards Europe remains low so far this year. The latest Hargreaves Lansdown Investor Confidence Index shows investors are least optimistic about the region, with a confidence score of 51 per cent; a score below 50 per cent shows negative sentiment. However, Hargreaves Lansdown points out European valuations are displaying value, with a cyclically adjusted price-to-earnings ratio of 13.6 compared to a long run average of 20.7.

Are there European businesses that are thriving despite the political uncertainty? And which funds are the best play on Europe this year?

John Husselbee

Head of multi-asset Liontrust Asset Management

The question of whether asset allocators should add exposure to Europe seems to be posed at the beginning of every year. But given the significant outflows from the region last year, it seems the love affair is yet to begin, with political risk from the rise in populism across the continent cited as the biggest fear.

However, these political woes are in danger of masking over the more positive fundamental outlook for Europe. Central Banks’ commitment to ultra-loose monetary policy is faltering due to signs it is no longer having a positive impact and the baton has been passed onto governments in the form of fiscal stimulus.

The resulting acceleration in economic indicators has come at a time when the outlook for the global economy is showing a marked improvement – we just need this more favourable environment to be translated into earnings and into share prices. Elections, beginning with Geert Wilders’ bid for victory in the Netherlands and closely followed by the French two-round system, will continue to dominate sentiment throughout the year. The negative feeling towards the region is understandable, but given the improving fundamental economic outlook perhaps investors should give it a second look.

Tim Cockerill

Investment director Rowan Dartington

I’ve always thought UK investors have been reluctant investors in Europe, tending to see it as a homogenous block that has one foot in the capitalist world and one in the socialist. Perhaps so, but it’s a very diverse place and offers fund managers a lot of opportunities from the under-researched small-cap stocks to large, high quality, global businesses.

The European economy is slowly improving, inflation is rising and the European Central Banks QE programme may be nearing the final phase. Bank lending has yet to kick in, but it seems to be getting closer. The politics are a worry and although Marie Le Pen is not expected to win the presidential election, too many shocks have happened lately to discount this.

We are overweight to Europe. Most recently value orientated stocks have led the market higher. Before then, quality growth had dominated. Going forward it seems likely that stocks are going to be judged more on their prospects than valuation anomalies which have now been eroded – if so a broadly diversified fund would be a good play.

Peter Lowman

CIO, Investment Quorum

Clearly, Europe is facing a fairly strong political headwind given the importance of the forthcoming elections. Understandably, concerns over a continuation of the populist vote are unnerving global investors, which in turn has led to a meaningful number of redemptions in European equity funds.

Inflation looks set to rise, which will reduce the purchasing power of households, while political uncertainty could weigh heavily on confidence. However, cyclical indicators are suggesting that the recently better-than-expected growth figures might continue and furthermore European economic fundamentals seem to be improving.

European monetary policy is likely to remain loose, as we go through 2017, while fiscal policy accommodative. Therefore, despite the political risks, a sense of optimism should not be ruled out.  Indeed, the outlook for 2018 looks promising as inflation contracts, and the pick-up in the global economy begins to feed through into Europe.

Arguably, this is a time for active stock pickers, rather than passives, therefore funds such as GLG Continental Europe, Miton European Opportunities, BlackRock European Dynamic and Oyster Continental European Select could be considered.

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Mike Deverell

Investment manager Equilibrium Asset Management

European equites divide opinion right now. Optimists point to their relative valuations compared to US markets, but the key word there is “relative”. European stocks don’t look as expensive as the US but they hardly look cheap.

US bulls can at least point to Trump’s tax cuts and spending plans but it’s difficult to make a similar case in Europe. The European economy is doing ok but it is hard to see a catalyst for further improvement. However, there many ways we could imagine the opposite, such as an escalation of the Greek debt crisis or a messy fallout from Brexit negotiations.

Political risk remains equally worrying. While the polls suggest Marine Le Pen won’t be the next president of France, the impact if she did get in could be massive. Her election could threaten the future of the Euro and the EU altogether.

That’s not to say there aren’t good opportunities or good companies in Europe. To take advantage I’d suggest a highly active fund able to invest very differently to the benchmark, such as Blackrock European Dynamic.

James Calder

Head of research, City Asset Management

The dilemma faced by those looking to invest within Europe is which weighs greater: an improving outlook for the market or political risk.

If one ignores the political aspect Europe is attractive on a relative value basis when compared with other equity regions. While it started down the road to recovery later than many of its developed market peers there are encouraging signs it is catching up.

The big “however” is what impact of political risk through 2017. The political signposts are clearly marked but I believe the key determinant is the French presidential election. If the result is considered market friendly, then this may well be the catalyst for a renewed interest in European equities. I also have to note that political results that the market should have taken negatively have failed to produce the results that were predicted.

As for our current approach to Europe, we remain cautiously positive, after reducing our exposure last year. Currency will continue to play an important role from a sterling-based investor’s perspective. In terms of opportunities we are currently assessing some European smaller company managers, but the largest concern I have is that are we currently in an exceptionally attractive buying opportunity but are missing it for the sake of political worries.

John Redwood

Chief global strategist, Charles Stanley

The Euro area economy is performing better. Growth is picking up, corporate earnings are expanding, and progress is being made with mending the commercial banks in Italy that have stretched balance sheets.

Banking shares have started to perform better on hopes of future credit growth and restoration of more normal levels of profits. Judged on the economics, European shares should be a worthwhile investment this year.

The problem lies with the politics. The Greek problems have not gone away. There may be more bad headlines about Greece’s inability to cut spending further and to repay debts on time, though we do not think it will become a major threat to the Euro system.

Populist parties in the Netherlands and France are setting out agendas that are hostile to the Euro and the current structure of the EU. Were Le Pen to win against the common prediction and the current opinion polls, many investors would regard Euro investments as higher risk.

At Charles Stanley we are recommending a neutral position in European shares, but are watching it carefully in case the political situation justifies a more negative stance.

David Coombs

Head of multi-asset investments, Rathbones

Falling petrol costs and extremely generous monetary policy have given Europe a tailwind over the past six months or so. Unfortunately, these effects are unlikely to continue.

The oil price has since returned to a relatively stable $50-$60 range, and the European Central Bank appears ready to unwind quantitative easing rather than accelerate it. Meanwhile, populism is on the rise. In several countries – most pressingly France, the Netherlands and Germany – extreme parties are gaining ground. Not only could this mean poor trade and business policies, and greater uncertainty, but it pushes true fiscal and political union further from the continental agenda.

As unpalatable as ever greater union may be to many of its citizens, it is the only way the monetary bloc can deal with the imbalances created by its two-speed economy.

Germany is close to overheating as property prices soar, unemployment falls below 4 per cent and inflation bumps against the ECB’s target. Meanwhile, almost 10 years after the credit crunch, Italian zombie banks stagger onward without definitive resolution, and Greece sports an unemployment rate of 23 per cent and anaemic demand. Massive debt write-offs are needed to get southern European banks lending again. And substantial labour reform is needed to get the unemployed in the southern states into work in order to improve consumption and domestic demand.

Owing to the above, we continue to underweight the eurozone and avoid the peripheral nations entirely.