Vive la difference consumer debt

Europe\'s early resilience in the credit crunch evaporated, but many advisers already see signs of recovery. One reason is that consumers in the eurozone are less indebted than those in Britain.


Europe’s early resilience in the credit crunch evaporated, but many advisers already see signs of recovery. One reason is that consumers in the eurozone are less indebted than those in Britain.Europe has been described as the laggard of the credit crunch after its economic resilience during the early stages proved a false hope for investors seeking a haven. Many Adviser Fund Index (AFI) panellists, however, say they are not yet disenchanted with the eurozone and possibilities might still present themselves over the next year.

Germany, Europe’s biggest economy, appeared to be substantially better placed than America and Britain as, despite a few minor banking casualties, its export competitiveness seemed to provide comfort. This was proved the case over the first quarter of 2008 as the economy grew by 0.4%, much higher than the 0.1% that had been forecast, on the back of export revenue.

Although Germany’s exports increased by as much as 7% over the first half of the year it was clear from the economic figures being published that this masked a significant slowdown in domestic consumption. As the global economic picture deteriorated, export demand fell back and with it eurozone growth prospects. The second quarter saw a drastic reversal of fortunes, with the German economy shrinking by 0.5% and the eurozone as a whole contracting by 0.2%.

Sam Sibley, an investment adviser at Beckett Asset Management and an AFI panellist, says that despite a worsening economic outlook in the short term she has not altered her view of the region over the longer term.

“Europe is appealing because it covers such a large geographical area,” she says. “In particular it is looking attractive due to rising dividends, which will be important for investors going into 2009.”

Sibley holds Resolution Argonaut European Income and Neptune European Opportunities, managed by Rob Burnett, in her AFI portfolios. Burnett’s fund, despite falling 26% over 12 months, still boasts a five-year return of 111.9% against an Investment Management Association (IMA) Europe Excluding UK sector average of 32.1%.

“The way that Neptune does its research has allowed the fund to avoid some of the worst-hit areas, such as banks,” says Sibley. “We plan to keep our weighting in Europe and our fund picks the same in November’s rebalancing.”

Over the short term the global economic picture is looking grim and the challenge for managers has been to avoid the worst-hit sectors rather than find strong outperformers. With a longer investment horizon in mind, however, some economic stories are beginning to look more compelling than others.

Tim Cockerill, the head of research at Rowan, points out that European consumers do not in general have the level of debt that British consumers do. “Historically,” he says, “Europe tends to do better than people expect as it tends to be overlooked and underestimated economically. I would expect Europe to surprise on the upside, in contrast to many other markets.”

As with all investment decisions in volatile market conditions, the difficulty with holding a long-term positive view on a region is timing the move from a defensive position to a more aggressive allocation that takes advantage of growth. Cockerill says this dilemma is illustrated by the contrasting performance of Cazenove’s European Fund and Artemis’s European Growth Fund.

The Cazenove fund, managed by Chris Rice, has lost 20.6% over 12 months, placing it second of 107 funds in the IMA Europe Excluding UK sector. In stark contrast, despite strong growth of above 20% in the preceding three years, Artemis’s offering has plummeted 46.1% since last October.

“Cazenove Europe has done well as it was defensively positioned whereas Artemis has fared terribly,” says Cockerill. “If things turn around relatively quickly, however, Artemis should see a stronger bounce, but if not, Rice’s fund will continue to do better. This is the decision we will have to be making [in November’s rebalancing].”

The European Central Bank’s (ECB) decision to cut its basic interest rate from 4.25% to 3.75% in a co-ordinated effort with America’s Federal Reserve and the Bank of England was a positive sign for markets. It marked the first time in over five years that the ECB has cut rates and demonstrated that the bank was willing to target the slowing economies of its member states despite continuing inflationary pressures.

Another good sign is that last month’s pessimistic report by the European Commission, which forecast a “bleak outlook” for the eurozone and cut projected growth in the region from 1.7% to 1.3% this year, has failed to extinguish investor interest. Without the long-term threats of heavy consumer debts and – with the exception of Ireland and Spain – relatively smaller bubbles formed in the housing markets in these countries, the prospects for a sharper and more sustained recovery looks stronger than for Britain and America.

Some investors argue that signs of recovery are already presenting themselves. The Euribor rate, the key inter-bank euro lending rate, continued its easing trend last week, falling below 5% as a result of the interest rate cuts and ECB lending rule changes. The falls should help to alleviate some of the pressure in credit markets.

“I suspect [the lack of consumer debt] will be a key strength,” says Cockerill. “On that level Europe should be better off in the longer term than Britain.”

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).