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Sector focus: Why European banks are exciting investors again

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European markets have recently seen a rotation into value areas, away from growth or high quality stocks. This is evident just by looking at the MSCI Europe Growth index versus the MSCI Europe Value index, with the former having risen only 13.3 per cent in 2016 compared to the latter’s 24.4 per cent.

There are several reasons for investor interest in these sectors. Some argue the valuation premium for quality stocks is high relative to history and that, while holding these steady growers made sense in a deflationary environment, that is less the case now inflation expectations have been rising.

The fact this premium paid for pricing power and yield is being questioned could be a game changer. There will inevitably be winners and losers.

On the winning side, the strong correlation of European banks with the US 10-year bond yield since Donald Trump’s election victory has attracted significant interest. For the first time since the global financial crisis, they may find appeal with a wider investor audience.

There are a number of compelling funds investing in this sector. Our picks here all share a few characteristics we like to see: experience of companies and markets, consistency in the application of their investment philosophy and approach, well-constructed portfolios with a sensible view on risk and proof their methods can work over time.

Fund picks

First up is the Fidelity European fund, where we have a high regard for manager Sam Morse. Morse has ably demonstrated he provides a safe pair of hands over multiple investment cycles. The strategy he employs is thoughtful and measured, ensuring the portfolio is made up of steady businesses that can consistently grow their dividends.

While the fund’s performance objective may seem conservative, Morse looks to provide this in a consistent manner over an extended period: a performance profile that can be a high hurdle to many. The fund is likely to underperform during periods of strong equity market returns when riskier stocks are in vogue, and outperform in weaker, more volatile environments. This allows for a favourable risk-adjusted profile.

We also like the Oyster Continental European Selection fund, which is managed by Michael Clements of SYZ Asset Management. This fund is aimed at investors looking for a concentrated European ex UK vehicle. There is a strong quality mantra underpinning the strategy but, pleasingly, this is coupled with a focus on buying such companies cheaply.

Clements could be viewed as an opportunistic investor, as he believes valuation is important when buying quality companies, so is typically purchasing stocks when they are out of favour. As such, the research work is very comprehensive. In essence, the strategy is about Clements’ ability to identify a short list of quality businesses at a discount.

Performance can differ from a European ex UK equity index owing to the nature of the mandate but the manager is constantly thinking about what could go wrong with his stocks that would cause him to lose money. This is an attractive feature to have, especially for an investor with a longer-term horizon.

Finally, the Schroder European Alpha Income fund is a relative newcomer to the European equity space, having launched in May 2012. Its key attraction is the pragmatic investment approach that underpins the strategy. Companies are considered in terms of their sensitivity to different phases of the economic and business cycle, as well as other usual fundamental metrics, such as barriers to entry, valuation and dividend potential.

The portfolio can include a mixture of high or low yielding stocks that can be defensive, growing businesses or more cyclically sensitive in nature, depending on the opportunity manager James Sym finds attractive at the time. And while stock selection is expected to be the main driver of performance, it can also come from Sym getting the business cycle positioning right.

Amaya Assan is senior investment research analyst at Square Mile Investment Consulting and Research

Europe ex-UK part one
Europe ex-UK part 2

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