EuropeanJun 23 2014

Insight: Europe excluding UK

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Europe has been a difficult continent to invest in over the past five years. It may not have been an investor’s first choice for portfolio allocation. Having been plagued by a series of economic difficulties around the continent – particularly those in the eurozone –the region has faced immense troubles.

Starting in 2009, the European Union told France, Ireland, Greece and Spain to each reduce their budget deficits, but it became clear by December that year that it would be harder for Greece, as its debts reached €300bn – the highest any country had seen in modern history – amounting to 113 per cent of its GDP. The eurozone’s debt limit is 60 per cent.

Troubles in the countries continued for years after, with various downgrades along the way. Cyprus, France, Italy, Spain and Portugal all had their credit rating downgraded by S&P and Fitch even downgraded the UK from AAA-rated to AA+ due to a weakened economic outlook, but the agency said while its outlook is stable, there is no further threat to any further action taken.

But, in more recent news, European Central Bank (ECB) president Mario Draghi introduced a new wave of measures to help stimulate the eurozone economy, including cutting the deposit rate for banks from 0 per cent to -0.1 per cent in order to encourage banks to lend to businesses rather than to hold on to money.

But since, developed markets have come back with a vengeance, with a strong performing 2013. Despite European markets not performing as well as the US, it still saw strong returns – the MSCI Europe index rose by roughly 20 per cent.

Things seem to be improving for European funds. According to recent figures from the Investment Management Association (IMA), the Europe space – which comprises the Europe excluding UK, Europe including UK and Europe Smaller Companies sectors – saw inflows of £285 net retail sale, up from the average for each of the previous 12 months which was £172m.

Things have changed around in the last 12 months for the European excluding UK sector. April saw inflows of £191m, up from £37m in March this year. This is a stark difference to April 2013 when the sector saw outflows of £42m. The number is staggering compared to its counterpart sector which includes the UK, which saw inflows of just £9m in April.

European equity funds were in fact the third best selling sector, after UK and Global equity sectors. The IMA stipulates funds within the sector must invest at least 80 per cent of their assets in European equities and exclude UK securities – although they can be up to 20 per cent of the fund’s allocation.

Improving markets and fund inflows have been raising questions as to whether Europe could be 2014’s stand-out market performer. Better economic flows have increased business confidence in peripheral European companies, which improves investor sentiment and why the sector has been seeing an increase in performance and flows into the funds. Even Greece, Ireland and Spain have seen their markets increase with the MSCI country indices improving. A solid effort to reform the eurozone has been a success, with various continent-wide austerity programmes taking place.

Many European funds have maintained positions in the economically troubled countries, but have subsequently benefited in the long run after a performance tailwind during 2013 and the start of 2014. However, some markets may not just see economic difficulties this year, but political issues. Investors looking at Europe should take note of how much a fund is invested in countries with a strong backing behind far right parties, and others with strong ties to Russia. It has been a country that has been a controversial investment in recent months owing to its political issues with Ukraine.

Table 1 shows the top 10 performing European excluding UK funds over the past five years to 1 June. The Table shows cumulative performances based on an initial £1,000 investment over one, three, five and 10 years as at 1 June 2014, with net income invested. It also shows discrete performance as a percentage for the past five years.

The top performing fund is the £119m Invesco Perpetual European Opportunities fund, managed by Adrian Bignell. The fund’s highest allocation is to Switzerland and Germany – totalling nearly 30 per cent of the fund.

The sector is made up of 100 funds all of varying sizes, as can be seen in the Table. So it is clear by looking purely at fund sizes that European funds have not lost their popularity. For example, the sixth best-performing fund, the Jupiter European fund, managed by Alexander Darwall, has a market cap of £2.4bn.

The European excluding UK sector takes out any risks that come within investing in the UK. The UK is a unique space in that it is tied to Europe politically but it has its own currency. Although the UK is an open market with improving sentiment, it is a commodity rich index, and many investors may not want to be invested in such a market.

While there is still uncertainty in the space, the consensus is that European fund managers are still finding plenty of investment opportunities. But whether or not the eurozone will come out of the past five years unscathed is unknown. But having exposure to Europe adds an element of diversification, with some added risk with allocation to countries such as Greece and Portugal.

Five questions to ask:

1. What is the fund’s strategy? As with any fund, it is important to see how the manager intends to allocate the money. Whether or not the fund is a growth or value strategy may change the outcome in various market cycles.

2. How much does it invest in the UK? Europe ex-UK funds are able to still invest up to 20 per cent in the UK, but check how much the fund sticks to that IMA stipulation. It may bring different risks if the fund has a high allocation to the UK.

3. Does the fund have a large eurozone exposure? Although the issues are not as bad as they were three years ago, it is still necessary to look at where the fund is allocated to and how much risk you may be taking should it have a high eurozone exposure – particularly to countries such as Greece.

4. What market cap does the manager specialise in? Depending on the country, small-, mid- and large-cap companies can have a different meaning. Small-caps tend to come with more risk but there is far more room to grow a business.

5. Is the fund euro- or sterling-denominated? It may not make much different initially, but any major markets could affect an investment over time. Look to see if there is a sterling share class.