Does Europe hold the answer to US concentration concerns?

The term refers to 11 European stocks that have outshone the wider stock market in the region in recent years, and currently represent around a quarter of Europe’s equity market.

Coined by Goldman Sachs in 2020, the group includes GlaxoSmithKline, Roche, ASML, Nestle, Novartis, Novo Nordisk, L'Oreal, LVMH, AstraZeneca, SAP and Sanofi – so the acronym should really be Grannnolass (or Grannnllass if you want to acknowledge L'Oreal's actual first letter).

Granolas – another magnificent seven?

Comparisons have been drawn to the magnificent seven (Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia and Tesla), which carried the US market in 2023 – largely down to increased investor appetite in artificial intelligence.

And the granolas made up half of the gains that have pushed the Euro Stoxx 600 index to a record high.

While some experts have raised concerns about possible concentration risks in European equity markets, others say that unlike the magnificent seven, their broad profile avoids this.

Timothy Woodhouse, manager of the JPM Global Unconstrained Equity fund, has a slight overweight to Europe and has several of the granolas among his biggest holdings.

He said: "We often hear that the US is the only place to find exposure to the most powerful trends. Novo and ASML are prime examples that contradict the narrative that. The rise of Novo, for example, reflects what investors should be looking for in great businesses – true innovation.

"What Novo and ASML have in common is the relentless focus on continuing to innovate and this has driven them to their current market caps.

"It is not just limited to these names – there are many businesses in both Europe and the rest of the developed world that offer growth, at more reasonable valuations than you can find in the US."

AJ Bell has increased its exposure to Europe recently because it adds better value overall.

James Flintoft, the company's head of investment solutions, said: "In shifting towards Europe we’ve reduced some of that concentration risk in the US. The granolas are a more diverse group of companies and therefore the concentration risk they pose is not a severe as in the US."

Lindsay James, investment strategist at Quilter Investors, agreed that the success of the granolas reflects investors’ desire to back a range of companies. She adds the healthcare sector enjoying structural tailwinds has boosted the group.

James says: “While the outlook for the European economy is mixed, active investors in the region have in recent months been more confident about backing businesses with a globally diversified customer base, where the valuations can be favourably compared to a global peer group.

"It is also likely to be a reflection of the enduring popularity of passive investing, where the largest businesses enjoy a growing share of asset flows regardless of their valuation."

Europe makes up 8.7 per cent of the average allocation to equities in the Asset Allocator database (the average allocation to Europe taking into account the total portfolio is 5 per cent).

This is some way below the average allocation in the IA Global sector, where it is 15 per cent, and the MSCI ACWI, where it is just over 12 per cent.

Close Brothers comes in above this, with a Europe exposure which makes up 12 per cent of its equity allocation. The firm’s chief investment officer, Robert Alster, says: “Demand for our luxury goods, such as those sold by L’Oreal and LVMH, is fuelled by the growth of the upper middle class in China and South East Asia and is not easily replicated given the history and workmanship involved in their manufacture.

“Although our technology sector lags that of the US in terms of size, we have some niche world beaters such as ASML in the semiconductor manufacture space and SAP in software, both of which stand to benefit massively from the rise in generative AI – and we believe we are only in the foothills of growth in this area.”

Assuming the magnificent seven represent the US and granolas represent Europe is not something that should be taken seriouslyRichard Philbin, Hawksmoor

Richard Philbin, CIO of Hawsmoor's investment solutions, said: "Ultimately, the characteristics of the granolas are very different to the characteristics of the magnificent seven due to the sectors they operate in. Granolas, although concentrated in terms of numbers (like the magnificent seven) are more diversified in terms of industry, which should lead to lower correlation and potentially greater diversity.

"Assuming the magnificent seven represent the US and granolas represent Europe is not something that should be taken seriously though."

Elsewhere in the database, 7IM had a 6 per cent allocation to Europe at the end of January, which increased from 4.5 per cent.

Sam Hannon, investment associate at 7IM, calls the rise of the granolas a success story for European markets.

He says: “Given the meteoric rise of its neighbours just across the Atlantic, European equities haven’t quite got the same attention.

"But when you have quality businesses, with robust balance sheets and high margins, that tends to be a recipe for success stories – in the case of European equities, this is where the granolas standout.”

He adds the themes in the granolas had not benefited from the AI boom, as was the case in the US but he questioned whether the concentration of market returns among a relatively small number of European companies was part of the same phenomenon which had fuelled the rise of the magnificent seven.

Hannon says: “This is a bright spot for European equities, however could this concentration of companies be a result of the rise of market-weighted passive solutions?

“Instead, we have a standalone exposure to global healthcare companies [through AB International Healthcare] for the same reasons that have made part of the granolas successful.”

Peter Wasko, senior portfolio manager at Copia Capital, agreed that the rise of passive investing had played a part in the recent success of a relatively concentrated number of stocks - both in Europe and the US - since these larger companies will form a larger proportion of indices.

He said: "Even if you look outside of the US, most large cap stocks in Europe and the UK have significantly outperformed small and mid-cap companies over the past 24 months. Interest rates have been a big driver of this dispersion. Simply, small and mid-sized companies are generally more sensitive to rising interest rates as they tend to need to borrow more than larger companies and often at less attractive terms."

Addressing what he thought portfolio managers could do about this, he added: "We think you can find many areas of diversification by investing in other regional or value/income/style funds."

Tara O'Connor is senior reporter at FT Adviser