European equities were among the top performers in 2013, a year that saw remarkable gains across most developed equity markets in local currency terms, with the MSCI Europe index hitting a series of record highs.
So far, 2014 has seen a continuation of this positive sentiment. Although GDP growth in the currency bloc remains muted, there are some shoots of recovery. For example, PMI data across most of the bloc are in expansionary territory and trending upwards and spreads on peripheral sovereign bonds are tightening as investor confidence slowly returns.
European Central Bank chairman Mario Draghi’s ongoing commitment to do “whatever it take” to save the eurozone economy is undoubtedly playing a large part in the optimism, helping to alleviate concerns of record low interest rates and limited credit growth. Alongside the improving economic backdrop, valuations are also compelling – many sectors are still trading at a discount compared both relative to long-term averages and to other asset classes, offering tantalising opportunities for investors.
As a result, we remain moderately positive on the European equity market, reflected in our current modest overweight position compared with our third-party asset allocation model. In terms of style, we still think that a value and cyclical bias will continue to reward portfolios – even after a year-and-a-half of PE ratio re-ratings.
One fund we particularly like is the BlackRock Continental European Income fund, a “quality income” strategy that aims to deliver a 4-6 per cent yield alongside capital appreciation. The investment approach is unconstrained and seeks undervalued, quality companies with strong balance sheets. The team does not chase yield, as such, but likes the security of a business focused on dividend growth and distribution and so avoids companies with volatile yields and companies where the yield is at risk of a cut or suspension.
Another fund we hold is the BlackRock European Dynamic fund. It is an unconstrained, concentrated portfolio of approximately 40 stocks with the fund manager taking outsized stock and sector bets in line with his macro views to drive performance. The approach is primarily bottom-up and the manager, supported by a team of 13 analysts, aims to unearth companies with medium- to long-term earnings potential that is underestimated by the market, selling out of them once the inherent value is realised. This leads to a relatively high turnover of stocks.
Lastly, we like the Franklin European Growth fund. The fund aims to achieve long-term capital appreciation by investing in multi-cap European equities.
Using industry research, conferences, quantitative screens and sources, the team utilises a three-pronged approach to finding investment ideas: the bottleneck approach (searching along value chains for unique companies), the contrarian approach (searching in out-of-favour parts of the market) and the valuation approach (searching for companies with low valuations). The team focuses on minimising downside risk but their approach can lead to contrarian positions.
In Europe, with momentum playing out, we believe value-based, cyclical exposure will continue to reward portfolios.
Caspar Rock is chief investment officer at Architas