UK retail investors have been busy ditching their European exposure in recent times, with the Investment Association’s Europe ex UK sector notching up a hefty £2.9bn net outflow in the year to the end of April 2019. During that period, October 2018 was the only month in which investors put more money into these funds than they withdrew.
It’s not just retail investors withdrawing. Data from Money Management’s sister publication Asset Allocator, which covers the wealth management market, shows that discretionary fund managers have, on aggregate, pared back exposure to the region this year.
Much of this is due to renewed concerns over the outlook for the continental economy. Worries about the eurozone are such that the bloc’s equity markets can prove more closely correlated with its overall economic fortunes than is the case in other regions.
Indeed, although European stocks performed well in 2017 as domestic economies picked up, they have struggled more broadly over the past half decade. A look at other global markets shows backers of the region have risked losing out. The FTSE Europe ex UK gained 41.4 per cent in sterling terms over the five years to May 31 2019. That puts it behind the S&P 500, MSCI World, Japan’s Topix index and MSCI’s Emerging Markets index. The only major benchmark that lags Europe over this period is the UK’s own FTSE All-Share.
Past performance is not everything, but the outlook for the region looks equally gloomy. Europe is still home to economic laggards that make investors nervous. Italy, for one, has been mired in political turmoil and could now face disciplinary action over its substantial level of public debt.
Germany, traditionally seen as Europe’s economic motor, has also looked vulnerable on several fronts. The economy narrowly avoided a recession in 2018 and registered growth of just 0.4 per cent in the first quarter of 2019. Other metrics have started to reverse, too.
The country’s unemployment rate rose to 5 per cent in May – the first increase since November 2013. Business confidence slumped to its weakest level in four years during the same month.
At the same time, plenty of broader worries continue to linger for the eurozone. It contains several prominent troubled industries: banks, which have struggled to thrive in a low interest rate environment, are just one example. And trade disputes, from the US/China spat to Brexit, remain unhelpful for a region that has driven much of its past growth via exports. The eurozone manufacturing purchasing managers’ index, a closely followed gauge of export sentiment, came in at 47.7 in May. Any reading below 50 represents industry contraction.
Why bother?
Given all this information, clients might well feel unenthusiastic about any decision to throw money behind an imminent European recovery. But European stocks remain cheap compared with peers, and other threats, such as the prospect of imminent interest rate rises, have disappeared for now.
The region could also stand to benefit from a revival in the fortunes of value stocks, given its heavy exposure to certain beaten-up sectors. While growth names have strongly outperformed over much of the past decade, the gap in performance between these stocks and value strategies is now at its widest-ever level.
For some commentators, this is a sign that value investing could reassert its dominance in the coming years – though it is important to remember that such hopes have been thwarted many times of late.
A more obvious reason for optimism comes in the form of recent performance. As of early June, the FTSE Europe ex UK had returned 12.5 per cent year to date in sterling terms. That puts it just behind the S&P 500’s 12.8 per cent. But while European markets may not have been able to overcome the dominance of US shares, they are ahead of indices in the UK, Japan, emerging markets and Asia over this time frame.
Investors should also remember that both the economies and companies in Europe are highly diverse, meaning stockpickers have many ways to play this region even in tough markets. A look at open-ended funds alone confirms this: in the five years to the end of May 2019, 31 of the 96 relevant IA Europe ex UK funds have beaten the index.
Simply the best
With just under a third of funds from that sample outperforming, it remains important to pick the best names. With that in mind, we have identified the top 20 open-ended funds and investment trusts by five-year returns to the end of May, as outlined in Table 1.
A look at the top fund over five years illustrates just how mixed the outcomes have been for some of those investing in Europe. Man GLG’s Continental European Growth fund, managed by Rory Powe since late 2014, has topped the table by returning £1,940 from a £1,000 lump sum over five years. The fund’s biggest bets are easy to spot: around a quarter of its assets are in Germany, with a heavy preference for consumer discretionary names. Mr Powe runs a concentrated portfolio, with just 31 holdings in the fund at the end of May.
The fund sits in third place within the same cohort on a 10-year view, but has fared less well recently. The strategy has underperformed its sector average over one year, and on a three-year basis it sits in the bottom half of this sample.
When it comes to more recent performance, a specialist offering is ahead of the other funds in Table 1. JPMorgan Russian Securities, an investment trust, comes out ahead over one and three years. However, it’s important to note this is down at least in part to the performance of the specific market in question: the RTS index, the trust’s benchmark, has enjoyed better recent performance than many of the funds in our analysis.
As far as more generalist offerings are concerned, a well-known European stockpicker has clearly made his mark. Alexander Darwall, who works on both the Jupiter European fund and its closed-ended equivalent, European Opportunities, is prominent across most time horizons.
Because our analysis only includes products with five-year track records, some more recent launches are been excluded from the analysis. But even when those are added into the mix, Mr Darwall’s offerings stand out.
Changing of the guard
Mr Darwall’s funds took a hit earlier this year when Wirecard, the largest holding for both, saw its shares plunge on the back of Financial Times reports raising questions over the company’s accounting practices. At the end of May Wirecard represented 8.9 per cent of the open-ended fund and 14.6 per cent of the trust.
Another pressing concern for investors is the fact that Mr Darwall is set to relinquish control of the open-ended fund, ceding control to former Columbia Threadneedle fund manager Mark Nichols. However, he will continue to run the investment trust.
For those seeking an alternative to Jupiter’s offerings, there is plenty of variety on offer. Our five-year analysis brings in funds from 16 different providers and a variety of different approaches. Table 1 contains four investment trusts, two funds with an explicit onus on income, and offerings from well-known providers and specialist, boutique asset managers alike.
While the analysis only takes in funds that have proved themselves over a longer time horizon, there is one other name that lacks a five-year track record, but has stood out since its launch in December 2015. Miton European Opportunities, which is managed by Carlos Moreno and Thomas Brown with a bias toward medium-sized companies, would sit in second place over three years and third over one year if included in our table.
Ups and downs
Funds operating in this space have witnessed serious volatility in the past: the average IA Europe ex UK fund lost nearly 16 per cent in 2011, a year that saw the eurozone debt crisis reach its peak. Life has been calmer in recent years, but European equity funds can still experience ups and downs.
A look at the discrete annual returns in Table 1 illustrates this clearly enough. In the year to May 31 2017, a period that saw the pound tumble to a multi-decade low after the Brexit vote, the average IA Europe ex UK fund gained some 33 per cent in sterling terms. But returns elsewhere over this five-year period have been less heartening.
The year to the end of May 2016 saw the average fund in this sector lose 2.8 per cent, with a similar outcome in the 12 months to the end of this May. However, it should be noted that each of these periods were marked by broader market sell-offs affecting regions beyond Europe. Intermediaries will be encouraged to see how the top 20 fared over these periods. In each of these two down years, 11 of the funds listed in our table managed a positive return.
Our findings also serve as a reminder that funds delivering substantial returns can get caught out in difficult markets. Marlborough European Multi-Cap, which holds around two thirds of assets in small and micro-cap companies, made a gain of nearly 16 per cent in the year to 31 May 2016, going on to return more than 50 per cent in the following year. However, it made the biggest loss, of 6.6 per cent, out of those in our table over the 12 months to the end of May 2019.
From trade to longer-term monetary policy, much remains uncertain when it comes to backing Europe. But with the region once more moving ahead in performance terms, it could yet prove a success story for those willing to take the plunge.
