Index returns top S&P so far this year
Global equity managers are beginning to increase their exposure to European stocks, suggesting that active opportunities in the asset class are multiplying even as an end to the eurozone crisis remains elusive.
After having generally underperformed relative to other regions since the eurozone sovereign debt crisis emerged in 2009, European stocks have slightly outpaced many other major markets so far this year. The Stoxx Europe 600 index returned 19.7% for the year through Dec. 6, vs. 15.9% for the S&P 500 including reinvested dividends.
The Stoxx 600 also outperformed the MSCI Emerging Markets index, up 15.7% during the period, and the MSCI All Country World index, which rose 15.8%.
“There's still a sense that European economies are not out of the woods yet, so from a risk-adjusted point of view, we're not suggesting that (clients) pile into European equities,” said Jane Welsh, senior investment consultant at Towers Watson & Co., Reigate, England.
“But from a bottom-up perspective, there are opportunities,” she said. For example, there are global companies “that have been dragged down by the euro malaise that actually are more dependent on other parts of the world (for growth) than their domestic markets.”
Investors are considering buying European equities again for two main reasons, said Stuart Reeve, London-based managing director and director of research for the global equity team at BlackRock (BLK) Inc. (BLK) One stems from a statement made in the summer by Mario Draghi, president of the European Central Bank, that he will do “whatever it takes” to save the euro. Backed by subsequent political decisions, investor confidence in the eurozone has begun to stabilize.
The second is “from a valuation perspective, Europe looks more attractive,” trading on average at a 30% discount to U.S. stocks compared to a historical gap of between 10% and 20%, Mr. Reeve said.
BlackRock's global dividend income strategy, for example, has been adding to an overweight position to European equities within the past six months, said Mr. Reeve, who is lead portfolio manager. ( BlackRock declined to provide the specific percentage in the overweight position and total active European equities AUM across all strategies.)
In addition, European equities yield an average of 4% in dividends compared with an average of 2% for U.S. stocks, said Neil Dwane, managing director and chief investment officer for Europe at Allianz Global Investors, Frankfurt. Particularly when comparing global companies, European stocks can be a better value. For example, shares in Royal Dutch Shell PLC are relatively cheaper than Exxon Mobil Corp. in terms of such measures as a price-to-earnings comparison. Shell is trading at a p/e ratio of 8, compared with 11 for Exxon.
“We're now overweight Europe,” Mr. Dwane added. AllianzGI manages €23 billion ($30 billion) in European equities across all strategies. At the end of October, its Europe equity growth strategy had €7.6 billion, up 70% from the beginning of the year.
But investing in European-listed equities is not the same as investing in European economies, Mr. Reeve added. “These problems aren't going away, and will take a long time to fix. Therefore, companies that are very exposed to domestic economies will be an impediment to good returns. We don't own European retailers, for example.”
Mr. Reeve is also steering clear of European financials. From a perspective of three to five years, “there are two questions that investors need to answer if they're investing in European financials: how much capital (banks) need; and what margins they're allowed to earn, which drive returns. I don't have great visibility on both.”
T. Rowe Price Group Inc. has gradually expanded its European equities team through the eurozone crisis, adding seven new positions in the past three years to a total of 22 dedicated European analysts and portfolio managers. Assets under management invested in European equities across all strategies were €17.7 billion as of Sept. 30.
Within the firm's global equities strategy, exposure to Europe is edging up, although it's still an underweight position. As of the end of November, the strategy was underweight Europe by 1.5 percentage points compared with the MSCI ACWI, up from an 8.1 percentage pointsunderweight position in March.
Although there are interesting opportunities in Europe, “there's also a huge dispersion of opportunities,” said Peter Preisler, director and head of Europe, the Middle East and Africa at T. Rowe Price in Copenhagen. “We're focusing our efforts where a quality bias comes through very strongly, since there's so much stress in the system.”
The German stock index DAX returned 27% year to date as of Dec. 5 while France's CAC 40 added 18% during the same period. The U.K.'s FTSE 100 lagged behind Germany and France with a 10% return, and Spain's IBEX 35 index fell 5% during the same period.
In aggregate, developed market European equities comprise about 24% of the MSCI ACWI index on a cap-weighted basis.
“Just buying into a market is not a productive way of investing in Europe right now,” Mr. Preisler said. T. Rowe's European equity core composite portfolio returned, respectively, 30.56%, 9.96% and -0.05% annualized over the one-, three- and five-year periods ended Sept. 30. In comparison, the MSCI Europe index returned 23.2%, 7.13% and -3.18% respectively for the same periods.
“We are finding good stocks in Europe with attractive valuations,” Mr. Preisler said, “but it's not just a valuation play. It's (also) a quality play,”
For example, certain global consumer companies in France are attractive because they have built an international customer base that makes them “really good companies to own,” said Virginie Maisonneuve, head of global and international equities at Schroder Investment Management Ltd., London. “In Germany, we're less focused on consumer companies and more focused on industrials.”
“We were very underweight in Europe during the first two quarters of this year,” Ms. Maisonneuve said. “We have since added (exposure) progressively based on extremely appealing opportunities, particularly in the kind of stocks that happen to be listed in Europe but are truly global companies.”
Across the portfolios managed by Ms. Maisonneuve's global and international equity team, which had about $16.7 billion in AUM as of Sept. 30, Europe now has a neutral or slightly overweight position within various strategies.
Mark Wynne-Jones, London, portfolio manager on Investec Asset Management Ltd.'s contrarian team, said the firm has been “gently, but steadily, increasing exposure to the eurozone over the past 18 months or so.”
Thanos Papasavvas, strategist in fixed income and currency at Investec, London, added: “Overall, the risk of a eurozone blowup has been contained.”
Investors have generally been rewarded when they've taken a skeptical investment view about the progress being made by political leaders in the eurozone, said Lars Kreckel, global equity strategist at Legal & General Investment Management, London. “In 2013, it's highly unlikely that there will be a straight-line improvement. "Two steps forward, one step back' still applies.”
LGIM, which manages about £900 million in active European equities assets, has been modestly overweight since late summer. However, “we prefer emerging markets equities” over European and U.S. equities, Mr. Kreckel added.
Skepticism on eurozone equities prevails at HSBC Global Asset Management. “What's driving the global economy will come from outside of Europe, not within Europe,” said Julien Seetharamdoo, senior strategist in the firm's macro and investment strategy team based in London.
“Our view is that we prefer equities over developed market fixed income,” Mr. Seetharamdoo said. “Valuations are attractive in some European markets, but they are also attractive in emerging markets and the U.S.
“Compared to Europe, where there are more concerns from a macro outlook and policy coordination point of view, we remain cautious.” HSBC generally hasn't increased the weighting to European equities within global equity portfolios.
This article originally appeared in the December 10, 2012 print issue as, "Euro equities back on managers' radar".