
Which is best for investors? The UK or Europe?
The UK and Europe make awkward neighbours, from the Norman Conquest to Brexit. For investors they offer attractive investment opportunities, but in different ways.
Britain tends to have greater exposure to oil and mining companies. Europe’s success is in strong luxury goods brands and technology.
Investors don’t have to choose between the two markets, (it’s perfectly acceptable to have some of each in a portfolio), but they are separate beasts in terms of opportunities right now.
FundCalibre spoke to three fund managers investing in Europe and three focused on the UK to find out what is exciting them most in their respective camps – and why you should pick their particular territory.
The UK
Strong dividend culture
“The UK has a stronger dividend culture than Europe and the yield on the UK market at 4.1% is around 1% higher than in the Eurozone (as at 12 June 2023),” points out Charles Luke, manager of the Murray Income Trust.
He adds: “The UK equity market trades on a more attractive multiple of 10 times forward earnings compared to the Eurozone at 12 times, albeit some of this will be explained by sector differences.”
The Murray Income Trust invests principally in high quality UK equities that generate their revenues around the world but trade on a discount because they are listed in the UK. However, in a cheeky little move, it can also invest up to 20% in overseas listed companies, like European giant LVMH which provides access to attractive areas of the market such as luxury goods – in other words, investors in this fund can have the best of both worlds.
Undervalued stocks
UK equities remain significantly undervalued relative to Europe and other developed markets, says Sid Chand Lall, manager of IFSL Marlborough Multi Cap Income fund, as international investors worry about the volatile politics and Brexit impact.
Broker Panmure Gordon calculated recently that valuations of UK companies are on an average discount of 18% to comparable businesses in other developed markets.
“We believe UK companies look highly attractive at current valuations, as highlighted by a recent flurry of merger and acquisition activity,” says Sid. This included Deutsche Bank agreeing to buy the broker Numis, which Sid holds in the fund, at a 72% premium to the pre-deal share price.
“The discount attached to UK equities is even higher among the smaller companies we favour, and we don’t believe it will last forever,” he says. Historically, UK small caps have achieved substantially stronger share price growth than larger counterparts over the long term, and with dividend income this outperformance is significantly greater, he adds.
Banks and utilities
Sue Noffke, head of UK equities at Schroders, likes UK banks as “the cheaper end of the sector, relative to European banks,”. Should stocks move to their 10 year historic valuation multiples, she expects share price upsides of close to 100%.
The benefit of higher interest rates takes longer to hit UK banks’ earnings per share versus European rivals, due to a “structural hedge”, she points out. But as this hedge rolls over in the next five years, UK banks will get a big boost not factored into their valuations.
HSBC and Standard Chartered also have exposure to Asia, where growth should be positive. Schroder Income Growth, which Sue manages, is overweight UK banks at 11.2% for the fund versus 9.3% for the index.
Matt Bennison, who helps Sue manage Schroder Income Growth, told us he also likes utilities. To achieve the UK government’s target to connect to the grid 50 GW offshore wind generation by 2030, National Grid plans to invest up to £40bn by 2026, split equally between the UK and US.
Schroder Income Growth holds the National Grid (2.6%), SSE (2%) and Drax (2%) for their growth opportunities, and attractive and growing dividend yields; 5.5% at National Grid, 3.3% at SSE, 4.2% at Drax.
Europe
Strong industrial base
“The biggest difference for small and mid-cap investors like us is Europe majors on making things, while the UK majors on finances and services,” says Alex Magni, lead manager of the LF Montanaro European Income fund.
Europe, he points out, has a vibrant industrial base offering a plethora of high-quality manufactured goods and components, chemicals, branded consumer goods and food technology, to name a few. “It also has world-class med-tech and healthcare sectors, not to forget the importance of its semiconductor equipment manufacturers,” he says.
LF Montanaro European Income is invested in all of these themes, with a full third of the fund in industrials.
Reshoring trend
European markets were incredibly cheap this time last year, Mark Nicols, manager of the Jupiter European fund, points out, due to concerns around inflation and interest rates, and fear about how the Ukrainian war would impact the European economy. But Mark remained patient.
“We seek investments in growth and quality companies, and last year the market chose to forget about the long-term prospects of some of these businesses,” he says. “But Europe has some great companies benefiting from powerful long-term structural themes and with attractive valuations.”
For example, he says, one of the biggest geopolitical themes right now is the “reshoring’’ of production, mainly moving it away from China, with European companies very exposed to the trend for capital goods companies and semiconductor equipment, for instance.
“We also believe there are great opportunities in Europe to invest in companies with exposure to secular growth trends such as data and digitalisation, ageing populations, emerging wealth, and automation,” he says.
Artificial intelligence
European companies are also set to benefit, Tom O’Hara, co-manager of the Janus Henderson European Focus fund, believes, from that current talk of the town, artificial intelligence (AI).
“The AI-mania that has started to grip markets, post NVIDIA’s announcement they would see very strong sales growth due to AI-related sales in the second quarter, has started to trickle down to Europe,” he says.
European beneficiaries include capital goods businesses exposed to the AI growth supply chain, such as semiconductor manufacturing equipment firms like ASML, ASM and Besi, along with Siemens and Schneider, both of which have large data centre hardware/software businesses.
“The economic prospects of Britain over the next two years do not look good,” says Tom, “so why wouldn’t the natural conclusion be to look to invest in the UK’s closest neighbours where things seem slightly less bleak?”
Photo by Christian Stahl on Unsplash