There is a strong case behind increasing exposure to the Europe ex UK sector, but how should advisers go about it? Patrick Murphy, director at PureResearch Group, takes a look.
It is fair to say that most multi-asset or fund of funds managers would agree the European equity market looks to be good value.
Compared to US or UK equities, continental Europe looks cheap on a basis of p/e ratios, albeit more expensive than emerging market shares after their recent falls, and broadly in line with the Japanese market after its strong run last year.
On a pure asset allocation basis, the case looks strong for advisers to increase exposure to Europe.
Europe: Active or passive allocation?
The economic data may make for confusing reading, with unemployment still appearing around 12% across Europe. However, notably, it is the peripheral countries pushing this figure up, such as the so-called PIGS – Portugal, Ireland, Greece and Spain – with no to slow economic growth and unemployment reaching as high as 28%.
It is worth noting, though, that during 2013 the equity markets of countries with the worst economic data were some of better performers, as institutional investors began to shift back to them based on their gradually improving outlook.
The intuitive belief would be that this backdrop creates the best opportunity for active, stockpicking fund managers to perform well in the coming year, where there is no clear ‘momentum’ behind markets.
And with many of these countries in the early stages of economic recovery, history suggests those funds with a bias or an ability to invest in small- and mid-cap companies should do well, as much of the market issues still relate to large-cap stocks.
Making sense of it
However, our analysis shows just how difficult a sector European equity funds are to analyse.
The top 20 funds, based on our Forward Perspective Ratings as at 31 December 2013, shows a mixture of active funds with strong long-term track records, such as JP Morgan Europe Dynamic, Cazenove European and Artemis European Growth, whose pedigree stretches back over the previous decade (see table 1 below).
Joining this list are funds with shorter, three-year track records, such as Invesco European Opportunities or GLG Continental Europe and, notably, two ETFs: Lxyor Eurostoxx50 and iShares Euro Dividend also make the top performers.
What this seems to indicate is the importance of dividends in both the active and passive funds, which would, again, be in line with previous market cycles. It also shows that using a strategy of allocating between both styles of fund would be appropriate.
Our Forward Perspective Ratings are based on a systemic analysis process created by two US professors, Dr Russ Wermers and Dr Allan Timmermann, through Parala Capital, a firm they founded in 2008.
The process shows that key economic factors such as interest rates, rising or falling GDP or unemployment, directly relate to the performance of an asset class, and this performance is likely to be repeated over an economic cycle.
Active v passive
The research can be used to differentiate between active fund managers, as well as between passive managers.
Using our data, it is clear the top 20 funds have also been consistently among the top performing over the previous three years, with over 50% being in the top two quintiles when assessing their three-year annualised returns (rank 5/5 and 4/5).
We can see there is something of a rotation in performance coming, with some of the stockpicking funds looking as if they will perform less well in the coming year, as indicated by a Forward Perspective rating of 1 (table 2 below).
An analysis of those funds that have improved most in rating from June to December last year shows the opportunity lies with ETFs, with only two of the top ten most improved funds being actively managed (table 3 below).
These two – HSBC GIF Euroland and Smith & Williamson European Growth - were rated 1 and 2 respectively back in June, indicating they would not be among the top performers. These two funds have appeared outside of the top two quintiles based on their historic three-year annualised performance.
Now, with a move in the business cycle, both funds have moved to a 5 rating, indicating they should perform well this year.
For advisers looking to allocate client money to European equity markets, a mixture of ETFs and actively managed portfolios may be the best route. If you remain cautious, diversifying across two different types of active or passive funds with strong forward ratings is a sensible way to get exposure.
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