Micro management key in Europe

Despite Europe’s continuing economic woes, fund managers believe slow progress is being made and are focusing on the strong global earnings profiles of many European companies

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The mismatch between Europe’s beleaguered economy and what is happening in stockmarkets is becoming ever more acute and fund-of-fund managers are gearing up towards bigger positions.

With the plethora of economic woes continuing to hammer the already battered continent, investors could be forgiven for turning their backs. Government debt levels in the periphery appear to remain unsupportable and recent events in Portugal and Greece are firm reminders that the eurozone crisis remains a long way off any permanent resolution.

Aidan Kearney, co-head of multi-manager funds at Aberdeen Asset Management, says: “The relapse in rising bond yields is symptomatic of the eurozone crisis as a whole, with politicians becoming complacent and not making effective use of the time bought by the initial support measures provided.”

But despite the environment, Kearney recently reduced his underweight position in Europe and now holds more of a neutral stance versus his peers.

He adds: “There are a couple of aspects behind this. Firstly, while it has been slow, we do acknowledge that progress is being made. Secondly, it is important not to confuse the macro with the micro environment; Europe is home to many world class companies which should not be ignored merely on where they happen to have originated and are therefore listed.”

Notably while the UK has been enjoying increasing signs of recovery, returns from European (ex-UK) equity funds have comfortably surpassed UK All Companies over the past 12 months (to 8 July), respectively achieving 33 per cent against 23 per cent. And over the past six months, the embattled continent is still ahead, albeit modestly at 12 per cent, against 11 per cent.

F&C’s co-head of multi-manager Gary Potter acknowledges that while Europe is trawling along the bottom in terms of its economic recovery, versus the UK and the US, he does not anticipate the environment to get much worse.

He says: “The general economic backdrop of the world is much better than it has been and hopefully we will be in a better place next year. In Europe stocks are very cheap and while we are underweight, we have reduced that position and are looking to move to a more neutral stance.”

But a long road lies ahead for the continent as whole. The currency bloc remains mired in recession despite the fact that the latest economic indicators have improved notes Kearney.

He says: “Fiscal austerity plans have continued apace, although the European Commission has granted marginal increases in the time horizon of selective economic reform programmes, including that of France and Spain.”

Banks have still not cleaned up their balance sheets so the supply of credit will remain tight and without this it is hard to see any meaningful expansion in the economy argues James de Bunsen, manager of the Henderson Income & Growth fund. 

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He adds: “The only thing keeping yields at manageable levels is rhetoric from the European Central Bank. So far it has all been words and no action. Its president Mario Draghi has not really been tested. It will be interesting to see how the eventual withdrawal of liquidity by the Fed will affect European government bonds.”

With these factors in mind, alongside aging demographics, huge youth unemployment, little progress on structural reforms outside Ireland, Europe as a whole may find it hard to attract capital notes de Bunsen.

He says: “Forecasts of a Japanese style lost decade may possibly be too benign given how reliant the continent is on external funding, unlike Japan, plus there is the potential for widespread civil unrest if youth unemployment continues to run at over 50 per cent.

“The ECB is still trying to do its bit but it will never have the freedom to act as the Federal Reserve and Bank of England have done because of Germany. But once the German elections are out of the way in the autumn there is potential for further softening on austerity and more unconventional policy actions. The Germans however will always remain opposed to such actions as they are simply not appropriate given the strength of their own economy.”

On the plus side de Bunsen acknowledges that valuations do look attractive compared with most other regions.

He says: “Company balance sheets are in very good shape and many companies have strong global earnings profiles. A meaningful recovery in the US would be a big positive for Europe as well, and growing conviction in such an outcome could see European equities outperform as they have become a very high beta trade. Overall we remain slightly underweight European equities and have been using futures to hedge when volatility has picked up.”