Most investors held underweight positions in European stocks during 2012: understandably given the top-down political and economic concerns.
With the Eurozone in crisis, fears of a Greek exit or the total disintegration of the euro, it was not the brightest of environments. When combined with fiscal austerity, high unemployment and massive debt burdens across Eurozone countries, Europe itself looked unattractive on an absolute and relative basis. Investors had over the past few years steadily reduced their exposure to the region, with less regard for the underlying company fundamentals.
So why did we remain overweight in the region throughout the second half of 2012 and now also into 2013?
As a portfolio manager, you not only have to analyse a situation, but assess whether your view is also the consensus view. If it is not, then there may be a reason to take a divergent view from the market.
Our overall investment philosophy at times leads us to use active stock pickers; in the current low growth environment we have preferred managers who seek out high quality companies with strong balance sheets and stable earnings, while also pragmatic enough to see specific opportunities in the more cyclical sectors too.
Despite the current climate, there are good examples of such companies, even in struggling economies such as Spain. With stock correlations at historically high levels, many were available at attractive valuations.
We invested in several funds that managed to successfully position their portfolios to benefit from this last year. These include the BlackRock European Dynamic Fund and the Henderson European Selected Opportunities Fund, which returned 26.4 per cent and 20.4 per cent respectively in 2012.
So what are the prospects for Europe now?
Overall, tail risks seem to have been reduced and the picture is now relatively more positive than in 2012. This is partly due to the ECB president’s pledge ‘to do whatever it takes’ to preserve the euro.
And it was not just words: actions spoke the loudest. In the summer, the ECB lowered its main lending rate from 1 per cent to 0.75 per cent.
Then in September it gave substance to its pledge, unveiling the Outright Monetary Transactions, which offers potentially unlimited purchases of short-term bonds for governments under siege in the markets, albeit with very strict conditions.
The impression is the political will exists to ensure the survival and growth of the European project. Yes, there are still fundamental economic problems to address, such as slow growth in previously better performing countries like Germany.
However, the reduced likelihood of tail risks allows you to concentrate more on the fundamentals of companies and sectors across Europe, and less on the macro risk.
For long-term investors, we still believe that funds invested in globally-focused, European-listed businesses that are at a valuation discount to their US peers because of their domicile are attractive. Europe also remains one of the highest yielding areas.
Long-term European equity valuations approached historic lows as a result of the Eurozone debt crisis, and remain attractive despite the market rally.
The risk of a messy Eurozone breakup seems to have subsided for now. Risks remain with upcoming elections in Italy and Germany, and problems still reside in the banking sector.
However, Europe now has a stock market with above-average yield, below-average valuation and access to global growth. All of which looks relatively positive for the year ahead.
Caspar Rock is chief investment officer at Architas