The IA Europe ex. UK sector features a richer seam of successful active managers compared to many others. We can put this down to a variety of factors, with the breadth of opportunity across geographies and sectors being the most obvious source of market inefficiencies to capitalise upon.
A decade or so ago, it became more popular to emphasise sectors over geography in Europe but, ironically, the importance of assessing country risk has been utterly reinforced by the eurozone fractures. Furthermore, stocks in the region receive relatively poor coverage by the broking community, giving managers that do their homework a significant advantage.
By dint of the opportunity set, European equity managers are also more inclined than their US counterparts to take account of top-down factors when positioning portfolios and this pragmatism provides another strand of active risk. The nature of global investment flows also requires them to be more cognisant of the economic cycle, as the participation in European equity markets by global asset allocators, which is often tactical in nature, renders them more vulnerable to investor sentiment. This has been more overt in recent months, with European equity markets particularly sensitive to heavy ETF flows.
The importance of financials
The approach managers have taken to financials has been a critical factor in their ability to outperform or underperform over the past decade. Despite its travails, it remains the largest sector in the main indices, at a weight of over 20 per cent. Following the financial crisis, the majority of managers were quite correctly under-exposed to banks but in the rehabilitation phase they have been a more difficult play, with short bursts of strong performance having the potential to push relative performance off course. When it comes to structural holdings, most have played it safe by choosing the higher quality, less troubled banks, dipping into the recovery plays for tactical holdings only. Some also use banks as a quick way to increase or decrease beta.
This year has once again seen European banks and other financials at the eye of the storm and the whole sector has been de-rated. They face numerous challenges: the increased regulatory burden, greater capital requirements and the growing scale of non-performing loans. Now, with interest rates firmly in negative territory, concerns about the ability of financial institutions to sustain their business models on wafer thin net interest margins have come to the forefront. The beginning of the year saw precipitous falls in the share prices of even the most pre-eminent financial institutions. Although we have seen a rebound since, share prices remain very weak on a year-to-date basis. The European Central Bank’s expanded package of measures, announced in March, have injected confidence into the European credit markets but there is scant evidence equity investors’ worries have been permanently allayed.
The financials story partly explains why the IA sector features few funds that display “value” credentials. Since the crisis, financials have been the major value play and with most managers underweight, the sector’s aggregate tilt towards growth has become more overt.
As in other markets, a growth style has been in favour for several years, although this year has been more mixed. Now, European fund managers are not alone in struggling with the valuation case for those companies that have been able to forge a growth path through a lacklustre economic backdrop. This is seeing many managers focusing upon their highest conviction ideas where they can see clear stock specific drivers but, inevitably, this trend is typically not a bullish sign.
We feature nine funds within the sector, spread across various market cap/style categories:
Henderson European Selected Opportunities: A high conviction fund, that does not lose sight of relative risk. The portfolio can be adjusted tactically in order to mitigate relative risks for short periods of time, according to market sentiment and dynamics.
JOHCM Continental European: Achieves consistent relative returns by a strong reliance upon macro assessments and a highly active approach to positioning.
JPM Europe Dynamic ex. UK: Based upon a well-honed screening process that combines the factors of value, quality and momentum, and delivers a differentiated outcome, complementing more traditionally managed active funds.
BlackRock Continental European: Has a growth tilt but is managed with some adherence to the benchmark, with a high degree of pragmatism.
Jupiter European Special Situations: Also a pragmatically managed fund. Focuses upon high quality growth stocks but with deference to valuations.
Schroder European: Takes a disciplined, bottom-up process, seeking to generate consistent relative performance. Investment ideas qualify as quality, growth, value or restructuring, organised into a well-diversified portfolio that typically has a modest growth skew.
Threadneedle European Select: A concentrated portfolio of companies the manager considers to have superior business models. The portfolio incorporates meaningful sector skews, given the strict investment criterion.
Jupiter European: Seeks out long-term growth companies that display structural growth advantages, are soundly funded and have strong management teams. The fund is concentrated and has clear sector skews, with the manager paying little heed to the benchmark.
BlackRock Continental European Income: Seeks to achieve an above average income, without sacrificing capital growth.
Gill Hutchison is head of investment research at City Financial