During the height of the European debt crisis, investors flocked to high-dividend-paying companies in an attempt to escape the high levels of volatility affecting equity markets.
This has driven up valuations in sectors such as tobacco companies, pharmaceuticals and consumer staples, while sectors such as financials and industrials have lagged.
Axa Framlington European fund manager Mark Hargraves said the time was right to begin to look at “selected” cyclical companies.
“You need to buy good quality cyclicals that don’t need much of a recovery to perform well,” the manager said.
“This is not a rising tide lifting everyone – it is not like 2003 or 2009 when you could almost close your eyes and buy anything. But sub-sectors of the economy can do well.”
Mr Hargraves has invested roughly a quarter of his fund in financials and 14.9 per cent in industrial companies – sectors generally regarded as more economically sensitive.
Stephanie Butcher, manager of the £105m Invesco Perpetual European Equity Income fund, has almost a third of her portfolio in financials and a further 16 per cent in industrial stocks, according to the fund’s latest factsheet.
The manager said European equity valuations were so cheap that “the environment simply needs to be ‘less bad’ for Europe to be an attractive case”.
“Valuation, yield and dividend growth opportunities in Europe are, in our view, attractive, but not necessarily in the ‘traditional’ income sector,” she said.
“Where we currently see most potential is financials, the periphery and selected cyclicals, where dividend revisions are improving and valuations and pay-out ratios are low.”
Dino Fuschillo, European fund manager at Four Capital Partners, added that it was “time to abandon the defensive areas such as consumer staples”.
He said: “Valuations in sectors like these are rich and there is little disappointment built into the price. I don’t think the earnings growth profile is as dynamic as other sectors.”
The manager said he had recently added to existing holdings in phone manufacturer Nokia, car giant Volkswagen and digital security company Gemalto. He has also started new positions in automotive safety systems developer Autoliv and Spanish-based multinational electric utility company Iberdrola.
But Threadneedle’s Nick Davis, manager of the firm’s £503.4m European and £27.1m Pan European Equity Dividend funds, argued that assessment of valuations of high-quality, more defensive companies “really depends on your time horizon”.
“Clearly, if there is an improvement in the economic outlook, we might tactically expect some of these stocks to lag a sharp rally in the short term,” Mr Davis said.
“However, we maintain our conviction that investors with long-term horizons should continue to focus on high-quality businesses.”
Fidelity’s chief investment officer for equities Dominic Rossi warned that “a modest cyclical improvement should not be confused with structural recovery”, as the conditions necessary for a long-term embedded recovery across Europe were not yet in place.
In the past five years tobacco companies within the MSCI Europe index have more than doubled in value, gaining 113.3 per cent according to FE Analytics. The consumer discretionary and consumer staples sectors have also gained in excess of 100 per cent.
Meanwhile industrial companies have collectively gained only 43.5 per cent, and the financial sector has lost 7.6 per cent. The wider MSCI Europe index has risen 29.2 per cent.
In the shorter term, pharmaceuticals and healthcare companies have dominated in 2013 so far, with gains of more than 25 per cent, but financials and industrials have both closed the relative performance gap, gaining roughly 15-16 per cent.
