After a decade of underperformance when compared with global equities, multi-asset managers are becoming increasingly confident about the outlook for European equities.
Despite being buoyed by this week’s news that the eurozone economy expanded 2.2%, quarter-on-quarter, in Q2 2021, plus additional data which showed a rise in employment, Europe has been somewhat of no-fly zone for asset allocators in recent years.
According to data from the Investment Association, the £68.6bn ($94.7bn, €80bn) IA Europe ex UK sector has seen net retail inflows of just £320m over the last 12 months as investors have preferred the comfort and safety of investing in global funds.
Perfectly clear in hindsight
However Chris Rush, investment manager at Iboss, says the avoidance of Europe goes back further, propelled by the myth that holding European equities has acted solely as a detractor to multi asset portfolios.
“If is often quoted in investment circles that asset allocation drives 90% of returns,” he said. “So it is relatively easy to see why investors have overlooked European equities for several years as they have unperformed the MSCI World Index by, a not so insignificant 139% over the last 10 years.”
For investors looking to generate returns through geographical asset allocation alone, Rush said the lesson, in hindsight, has been straightforward. Any allocation to a European equity index has had a significantly negative impact on performance over almost all cumulative periods and relative to a passive global equity position.
However for Rush, the headline figures do not provide the whole picture. He argued that while an index position in European equities has hindered performance, he added that it has been possible to outperform the index by selecting certain active managers.
“Survivorship bias aside, the various Euro Stoxx 50 trackers and ETFs in the IA Europe Ex UK Sector have underperformed over 85% of the sector through the last decade,” he said. “This is an an indication that broad exposure to the largest companies in Europe has been a net negative to overall performance.
“Therefore, the opportunities of the previous decade were often outside of the most prominent names in the index, an enviable position for many active managers operating in areas where this certainly has not been the case, for example, the US and emerging market equities.”
Common touch
Much like the rest of the world, Europe’s best performing areas have been growth and technology stocks, which Rush said most certainly will have made it on investors’ ‘amber watch lists’ at the very least.
He added that not only have European growth stocks kept up with global equities over the last five years, but that European tech commoners have actually outperformed global equities by 66% over the same period.
“Despite the oft-cited rhetoric that Europe (including the UK) lacks all things tech, it is not actually true, Rush said. “The MSCI Europe Index currently has an 8% weighting in technology firms. While this is far lower than some other indices, there have been plenty of tech opportunities for active managers.”
Iboss has held two funds that have benefitted from this trend: the Premier Miton European Opportunities and Baillie Gifford European funds. Over five years to 23 August, 2021, the funds are up 178.85% and 145.64% respectively, outperforming the MSCI North America (110.74%), MSCI World (88.12%) and MSCI Europe (52.69%) indices over the the same time period.
“Whilst broad index exposure to Europe has largely had a negative impact, exposure to Europe through the right active managers has had a distinctly positive effect relative to the rest of the world’s equities,” said Rush. “Simply put, most of the alpha generated during the last decade has been sector not geographically based.”
ESG bonus
John Husselbee, head of multi-asset at Liontrust, is also currently bullish on the prospects for European equities.
Within the multi-asset team’s tactical asset allocation, each asset class or region is assigned a rating from one to five, with one being the most bearish and five the most bullish.
“We currently rate European equities a four as we are broadly positive on risk assets, particularly cheaper equity markets including Europe,” he said.
Husselbee noted that Europe’s vaccination effort continues to improve and that the region has been a major beneficiary of a global recovery and normalisation.
“Export-led European stocks are geared into a global recovery and consumer brands should benefit from high levels of spending power turning on post lockdown,” he said. “Overall, valuations look attractive and Europe is further along the ESG path on a company-by-company basis than other markets.”
Not all rosy
While currently underweight in Europe-ex UK, Yoram Lustig, head of multi asset solutions, Emea, at T Rowe Price, does see a number of supportive tailwinds for the region.
Lustig said that improving vaccination rates, a higher exposure to more cyclically-orientated sectors that should benefit from economic recovery and attractive valuations relative to the US, are all positives for European equities.
“Continued monetary policy support and the recent launch of the EU recovery fund should provide additional tailwinds,” he added.
However, he said factors including the region’s limited long-term catalysts for growth, the limited scope for the ECB to stimulate further and fading demand from China, remain negative for investing.
Inflation question
Having benefitted from their exposure to European growth and tech in recent years, Rush said Iboss has begun to shift its European holdings to take advantage of what he calls the “unique make up of the European Index”.
“The indices significant exposures to financials, industrials and consumer-facing products have been persistently out of favour for several years, but, in our opinion, these sectors are currently on our ‘green list’ offering attractive valuations and diversification opportunities relative to other geographies,” he said.
Indeed as the expectations for inflation increase and the demand for physical/real assets rise commensurately, Rush suspects that many of these out of favour areas could see a resurgence of interest.
“We have shifted toward a more significant index weighting and incorporated managers with more flexible views on the relatively narrow growth versus value debate,” he said.
