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The pick of Europe

The last two years have been a difficult environment for companies in Europe. A synchronised global slowdown and major structural problems in several industries have made it difficult to improve on the progress made by European companies during the 90s.

The weakness of the euro has been a concern to some investors but this is a positive for corporate European companies in general, allowing them more scope to compete against other global companies.

The weakness of the euro can be seen as the inverse of the strong dollar and sterling. These currencies have benefited from strong economies relative to the other major economic powers and over the last several years have enjoyed big capital inflows. The UK was the best-performing economy among the G7 countries in 2001.

However, many European companies have performed well in corporate terms and in making absolute gains in share prices in a weak environment for global equities.

The simple and valid case for investing in continental Europe is to give investors a greater universe of stocks.

Continental European companies account for around two-thirds of the pan-European index in market capitalisation and around one-half of the pan-European free float.

The Continent offers UK and global investors the opportunity to invest in companies which are global leaders or which have an industry niche. Examples include investment banks such as UBS, car makers like BMW, mobile handset manufacturers such as Nokia and semi-conductor firms such as STM.

In addition to access to a wider universe of companies, increasing the ability to enhance investment returns and lower portfolio risk, there are also several important positive structural factors to be aware of in continental Europe. These include the continuation of restructuring and consolidation of European companies, which has lagged behind the US and UK. One example of a successful merger has been BNPP in the banking sector.

The absence of currency risk as a result of the creation of a single currency has allowed pension funds and retail investors in the eurozone countries to diversify equity portfolios away from their domestic markets, which are often too narrow to give enough portfolio risk diversification.

The next major change in Europe may well be the entry of the UK into the eurozone, which will allow UK pension funds to adopt pan-European equity portfolios.

Ongoing reforms in continental Europe in taxation, pension and labour markets are also positive for equities in the medium to longer term.

Provision for personal pensions, again significantly behind the US and UK, will increase cashflow into the equity market and increase awareness of the equity culture in continental Europe.

The last 12 months have been characterised by small periods of extreme optimism from investors on economic recovery where equity indices rebounded sharply and longer periods of realisation on the severity of economic and corporate economic conditions. The latter dominated with indices lower.

Our investment house held to a consistent investment stance over this period, favouring companies with more stable operating profits and sound balance sheets over companies with high debt and falling profit margins.

Economic convergence in continental European over the last five years has come at a time when companies have diversified sales globally to allow greater growth and less cyclical earnings.

What equity market a company is quoted in now means very little. Investing in Germ-any, for example, is no longer a way to invest in the strength of the German economy, as the major companies in Germany are exposed to many other countries globally.

This places the emphasis on stockpicking, with Germany an important subset of the continental Europe universe with interesting investment opportunities but also with companies in structural decline.

In the current economic climate, with so much uncertainty around, good companies with sound business models and strong management are the only safe bet.


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