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Mark Dampier: Equity income plays for a recovering Europe


When I began my career in financial services 32 years ago, Europe was not an obvious area to invest. In fact, if my memory serves me correctly, there was only one European fund available to investors.

At the time, European stockmarkets were not seen as particularly shareholder friendly and it certainly was not an area in which to seek an income. What is more, back in the 1980s most investors in Europe focused on bonds rather than equities.

How things have changed. Fast-forward to today and there are now around 120 funds in the IA European sectors. The region has also embraced more shareholder-friendly practices, such as paying dividends.

However, many investors still view Europe with suspicion. Issues surrounding the single currency, along with the Greek debt saga, have caused many to be wary. In my view, the sooner European governments recognise Greek debt will never be fully repaid and stop trying to sweep the problem under the carpet, the better.

Yet despite these issues, Europe has not been a bad place to invest over the past three years. Since the eurozone crisis, the average fund in the sector has risen 37 per cent. This proves patient investors, who are prepared to invest when sentiment is at its lowest, usually prosper in the long run.

Invesco Perpetual launched its European Equity Income fund back in 2007. Manager Stephanie Butcher took over in late 2010. Over her tenure, the fund has gained 59.1 per cent against the sector average of 39.2 per cent.

Does this mean investors have missed the boat? Butcher does not think so. While Europe still has some way to go, she believes the continent remains firmly on the path to recovery. Quantitative easing is supporting the price of financial assets, while a low oil price is also having a positive effect on some company earnings.

Prior to the financial crisis, company earnings in Europe were broadly on par with those in the US. Earnings fell sharply in 2008 but while firms in the US quickly recovered and have since surpassed their pre-crisis level the earnings of European companies remain 35 per cent below their 2007 peak. Butcher expects European company earnings to start picking up going forwards, although earnings in some areas, such as Spanish construction, are unlikely to get back to previous levels.

As an income manager, Butcher is often steered towards over-sold sectors, as this tends to be where the highest yields are found. For example, she was an early investor in financial companies: an area once written off by most others. The fund is now reaping the rewards as earnings in the sector are beginning to improve, aided by more stable growth and falling loan costs.

She sees the same potential in the oil and gas sector. While it is further behind on the road to rehabilitation, she expects earnings to improve as the impact of new management teams and a focus on cost control takes hold. In keeping with her focus on undervalued areas, the fund is heavily weighted towards the financial, oil and gas, and telecom sectors. She also favours Mediterranean countries avoided by most other investors, such as Italy and Spain.

Conversely, she has very little invested in pharmaceutical or consumer goods companies. In her other European portfolios, she had a high exposure to healthcare companies in 2009 when she felt the sector was undervalued. Investors were fearful over patent expiries; however, she felt cash flows were becoming more sustainable, as company management increased their focus on shareholder returns. Her view proved correct and the sector has risen strongly over the past five years. She now feels it looks overvalued and, as such, has cut exposure.

With interest rates across Europe and the UK unlikely to rise in the near future, the fund’s yield of 3.2 per cent looks very attractive and Butcher expects this to rise over the coming year. Dividends tend to be more robust and reliable than capital appreciation, yet they are often underestimated by the average investor.

This fund provides diversification to a typical equity income portfolio focused on the UK stockmarket. Indeed, for the many investors pursuing a drawdown strategy in their pension, it could be the ideal holding for the long term.

With its focus on more economically-sensitive areas, the fund is well positioned to benefit from an improving European economy. I would therefore suggest it is also suitable for investors who share Butcher’s view Europe is on the path to recovery.

Mark Dampier is head of research at Hargreaves Lansdown


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