EuropeanApr 2 2012

How are managers playing Europe?

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European markets started the year on a positive note, primarily driven by falling aversion to risk in response to the European Central Bank’s (ECB) three-year long-term refinancing operation (LTRO).

However, as we near the end of the first quarter of 2012, data may be pointing to yet more market turbulence.

The FTSEurofirst 300 index of top European shares lost 2.5 per cent in the week of March 16, its biggest weekly drop since mid-December, as a raft of weaker-than-expected data from China, the US and Europe prompted investors to take profit before incurring potential losses.

Didier Saint-Georges, member of the investment committee at Carmignac Gestion, says that this is because the ECB’s massive liquidity injections may have helped avert the threat of a European Lehman-style crisis, but has done little to improve the economic outlook for Europe.

“By tarring Italy, Spain and Ireland with the same brush as Greece, which deserves to be accused of exceptionally wasteful government spending, the European Commission and the IMF continue to force drastic austerity measures on these countries. What Spain, Ireland and Italy need is greater competitiveness, more labour market flexibility and higher growth, and not drastic spending cuts,” he says.

“At the same time, the banking sector is still being very overcautious – reserves deposited with the ECB as a safety net have increased by 50 per cent in just one year – while the euro remains overvalued. So while the ECB did manage to prevent the eurozone’s sudden demise, the prospect of a lengthy recession looms large and the self-destructive fiscal fast that this recovering region is inflicting upon itself is only making matters worse.”

Investors tread with caution

According to Jeremy Whitley, head of UK and European equities at Aberdeen, investors would be wise to remain cautious on the region in spite of the strong market rally that has accompanied the start of 2012.

“Last year we thought policymakers would face challenges in unwinding their interventions in what were fragile economies demonstrating some signs of recovery. In fact they ended the year having substantially deepened their involvement,” he says.

“As a result, the global economy remains very much on economic life support, being kept alive with ever larger injections of liquidity and cheap money. While this has most likely mitigated the worst-case scenarios of an implosion in the European financial sector and a disorderly break-up of the euro, it still leaves behind a global economy short on growth and long on structural challenges. We suspect a sustained period of austerity is upon us, which is sure to severely test political will amid the need for deep structural reform and fragile economic recovery.”

Mark Hargraves, manager of the Axa Framlington European fund, agrees: “The credit backdrop in Europe remains tight, which will continue to weigh on the wider economy.”

However, Andrew Goodwin, investment manager of the SVG European Focus fund, says the argument for European equities has never looked more compelling, a statement that has been, in some way, supported by recent market data.

European equity funds enjoyed inflows for the first time in 44 weeks, according to EPFR Global data, sparking hopes of a recovery in investor appetite for the region’s stocks. This is supported by European stock index futures, which opened higher on Monday March 26, as investors looked for bargains following a week-long sell-off.

But with European markets remaining unpredictable at best, quality appears to be the key theme among European managers.

Stocking up on quality

Mr Hargraves says that he is positioning his fund towards higher quality companies that can “weather a tougher economic environment”.

In January the manager reduced the fund’s exposure to banks UBS and DNB, and sold telecoms provider Ericsson, following disappointing results. He says that his allocations to different sectors – from being overweight consumer discretionary and underweight utilities and telecoms – contributed most to fund returns.

Mr Whitley is taking a similarly cautious approach. “Given this likely difficult investment environment for the next 12 to 18 months, our investment strategy of concentrating our capital into a sensibly diversified portfolio of good-quality companies with strong business models, sturdy balance sheets and talented management teams remains appropriate for the medium to long term.”

Laurent Millet, co-manager of the Artemis European Opportunities fund, is also opting for long-term, best-of-breed stock picks.

“More than half of our fund is invested in best-in-class quality stocks with strong balance sheets generating a high return on capital. Irrespective of market conditions, these masters of their own destiny are expected to generate healthy returns for the fund as they grow their sales profitably.

“A good example is Novo Nordisk, the Danish company focused on diabetes care. It grew sales by 12 per cent and its net profit by 19 per cent. As a result, its share price reacted accordingly, with a 20 per cent increase in February.”

However, Mr Saint-Georges says that, contrary to appearances at the beginning of the year, investing will still require some risk-taking in order to generate solid performance. Carmignac increased its multi-asset investments’ exposure to equity markets to near its maximum permitted level of 50 per cent at the beginning of the year.

“Nevertheless, we are continuing to tread very carefully and will happily reduce our exposure should the need arise,” he adds. “We have built a balanced portfolio that can be adjusted according to the risk profile. For example, our exposure to the dollar (42.6 per cent as of March 14) is one of our safeguards against a turnaround on the equity markets, which would result in a sharp decline in the euro. This type of protection allows us, moreover, to remain heavily invested in high-profile themes.”

Simona Stankovska is features writer at Investment Adviser