How active management can beat the stock market
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FundCalibre has 18 Elite Rated a Radar funds investing in European equities. In this sector focus, we take a closer look at the asset class: the pros and cons, current views and funds to consider.
Europe is home to a plethora of world-class companies – household names that boast dominant positions in sectors as diverse as engineering, banking, pharmaceuticals and consumer goods.
Among the most well-known are car manufacturers BMW, Daimler and Volkswagen, all of which hail from Germany, as well as Swiss drugs companies Roche and Novartis.
There is also LVMH, the luxury goods supplier formed from the merger of Louis Vuitton and Moet Hennessy, along with cosmetics giant L’Oréal, both from France.
The most obvious benefit is the sheer size of the market. With around 50 countries, numerous stock markets and thousands of companies, managers of European funds certainly have plenty of choice.
Of course, this can be a blessing and a curse. Narrowing down the investment universe is a significant challenge for even the most experienced of managers. There is also the thorny issue of politics and the various economic issues that different countries are often battling. In short, there’s a lot to consider when you’re looking at Europe.
Such concerns are generally thought to be one of the reasons why the amounts committed by UK investors to funds focused on this region lag the most popular sectors.
There is currently £70.5 billion invested in the IA Europe Excluding UK sector, and a more modest £3.1 billion in the IA European Smaller companies sector, according to the Investment Association*.
However, this is a long way behind IA Global, which has £178.6 billion of funds under management, as well as IA UK All Companies with £171.9 billion and IA North America with £91.7 billion*.
So, how do fund managers see the region? Do they believe it’s an attractive area in which to put their money or do they have reservations?
According to a European fund manager survey from the Bank of America, which was published in mid-December 2021, the general view is positive.
It found 28% of respondents expect the European equity rally to last until at least the fourth quarter next year, 15% believe it will peak in the first quarter, and 10% say it’s already happened. “A large majority of 62% see 5-10% upside for European equities next year, while 12% expect more than 10% upside,” it stated.
A net 20% of investors regard the market as undervalued, the largest proportion since March 2019, while 42% sees reducing equity exposure too early as the biggest risk to their portfolio.
If you’re sold on the idea of having exposure to Europe, you’ll then need to consider whether you prefer large or smaller companies.
Broadly speaking, the bigger, more established companies may have longer track records of delivering consistent, reliable returns to shareholders. However, they are closely followed by teams of analysts which means the chance of outperforming expectations – and enjoying sharp share price hikes – are less likely.
Smaller companies, meanwhile, have higher growth potential and can often be found in a variety of diverse industries. As opposed to their larger cousins, they are not that well followed. This gives them more potential to outperform. On the downside, though, is the fact they are often at an earlier stage in their life, which makes them potentially riskier investments.
Funds investing in the larger companies can generally be found in the IA Europe excluding UK sector, while the lower market cap names are in the IA European Smaller Companies sector. Here are some fund suggestions to consider:
T. Rowe Price European Smaller Companies fund is pan-European, also investing in the UK, and its manager is highly experienced, with a proven track record managing small and mid-cap portfolios in Europe.
He is part of a dedicated smaller companies analyst team, and the research process emphasises high quality, durable franchises with good capital allocation and high standards of corporate governance. The team's universe of stocks is less well covered by the asset management industry giving Ben plenty of scope to find unloved and undervalued companies. Buying early or in a contrarian fashion with a long-term view allows him to compound his winners
The aim of the Barings Europe Select Trust is to achieve capital growth by investing at least 75% of its assets in smaller companies – defined as being in the bottom 30% by total market capitalization.
The Barings team employs a growth at reasonable price (GARP) investment approach. It means they search for companies that can grow regardless of the economic backdrop, although they won’t pay speculative prices for them.
Research all Elite Rated and Radar European Smaller Companies funds
One possible contender is Threadneedle European Select, which aims to provide capital growth through investment in a portfolio of predominantly large-cap European equities. Manager Ben Moore likes firms that can defend their margins and industries with barriers to entry. The fund has performed particularly well in falling markets using this philosophy.
Investors who prefer the investment trust structure could consider the European Opportunities Trust, run by Alexander Darwall. It’s high conviction portfolio of European equities with a bias towards medium and larger companies. Alexander has a patient and value-aware approach, and generates his own ideas, primarily through company meetings. Firms benefiting from economic tailwinds and in strong positions within their industries are preferred.
And of course, Europe is also home to many dividend-paying companies and could therefore appeal to income-investors. BlackRock Continental European Income is a potential investment in this space. It invests mostly in large- and mid-cap securities and the team does not simply search for the highest yielding stocks but rather seeks to identify undervalued stocks in the high yield and/or quality space that offer sustainable dividends, potential dividend growth and inflation protection.
Research all Elite Rated and Radar Europe ex UK funds
*Source: Investment Association, sector rankings, 31 October 2021