This year has been a disappointing one for European equities
Year-to-date, the FTSE Europe excluding UK index is down 5.2 per cent. This compares with a 6.5 per cent gain by the S&P 500 and a 5.4 per cent fall by the FTSE All-Share (all in sterling terms), according to FE. This performance has not gone unnoticed by investors, who withdrew £759m from European equity funds between May and October of this year, Investment Association data shows.
Sentiment towards Europe has been hit by weak economic data, trade tensions with the US, and the UK’s planned exit from the EU in March.
You can also throw in tensions between Italy and the EU over the coalition government’s budget plans. The European Commission is worried about the coalition’s plans to increase spending, given the country’s debt. However, Italy’s governing populist parties won’t budge, prompting threats of fines from the EC unless Italy revises its plans. This ongoing conflict has the potential to set Italy on a course to leave the EU, which would create further uncertainty.
While the headlines aren’t that positive, I believe there are plenty of investment opportunities across Europe right now; not least because the region is home to a significant number of well-run companies which continue to make profits – whatever the weather.
While some data disappointed, it was very encouraging to see a 2.2 per cent rise in consumer prices across the eurozone in October, which represents a positive trend and vindicates the European Central Bank’s decision to end its quantitative easing programme by the end of the year.
The valuation gap between Europe and the US is another positive: while Europe excluding UK trades on a price-to-earnings ratio of 14x, the US market trades on 17x, Fidelity figures state. So it’s cheaper on a relative basis.
Another important point to consider is that as investors have turned cold on European equities, the selling has been indiscriminate. Fortunately, this has created investment opportunities.
With this in mind, I believe it is crucial to back an active fund manager who is able to identify companies which have the potential to dominate their sectors. Most importantly, a talented stock-picker must be able to spot a good bargain.
David Walton, manager of the FundCalibre Elite-rated Marlborough European Multi-Cap fund, is capable of doing just this. He believes lesser-known companies tend to be more attractively valued than household names, and these are usually found among small caps. The fund manager looks for undervalued stocks with above-average growth potential and strong management teams.
It is an approach that has paid off. Over the past three years, the fund is up 61.5 per cent versus 28.3 per cent by the average fund in the IA Europe excluding UK sector.
BlackRock European Dynamic manager Alister Hibbert is another fund manager to watch. He focuses on companies where he sees potential for an earnings or growth surprise. This may be because the company is misunderstood by the market, or it could be in a turnaround situation. We like that he has freedom to invest across the market spectrum.
Over the past three years, the BlackRock European Dynamic has returned 35.3 per cent, which compares to 28.3 per cent by the sector average. Looking ahead, we believe Hibbert and the team have the potential to deliver for investors.
RWC Continental European Equity manager Graham Clapp also seeks out companies likely to exceed market expectations. Once they have been identified, the team undertakes detailed fundamental analysis to understand the business better than the market. In their experience, the best ideas tend to be found among under-researched mid-caps.
Although the fund hasn’t been going for very long, we would expect Clapp and the team to deliver healthy returns over the long-term, which is why this fund sits in FundCalibre’s Elite Radar category of up-and-coming funds to watch.
While Europe has lagged the US in recent years, the status quo could soon change. Following the bursting of the 1990s tech bubble, European equities performed significantly better than their US counterparts between 2000 and 2007. It is worth remembering that this followed a period of strong performance for the US market. Although it is difficult to predict, October’s sharp sell-off – led by the US tech stocks – could be a sign of trouble ahead for America.
Investors in European equities have not been rewarded this year, but 2019 could prove to be a different story.
Darius McDermott is managing director at Chelsea Financial Services and FundCalibre