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U.S. investors not buying European equity pitch

Andy Barber
Andy Barber said U.S. investors avoid regional allocations.

Money managers, consultants and economists are growing increasingly positive on the case for European equities, citing relatively cheap valuations and further expected moves by the European Central Bank to boost the economy.

The case for Europe seems clear when considering the data. The MSCI Europe index returned 7.6% year to date through Sept. 30, compared with a 4.2% gain for the MSCI All Country World index.

The MSCI Europe even outperformed the U.S. market; the Russell 3000 returned 6.9% for the same period.

Last year was a different story. The MSCI Europe returned 20.7% for calendar year 2013, compared with 23.5% for the MSCI ACWI and 33.6% for the Russell 3000.

But some say the continued political struggles and fears of deflation mean managers are struggling to convince U.S. investors of the opportunity. One big reason is U.S. asset owners have moved toward global allocations and away from regional ones.

“For U.S. pension funds, their European exposure probably comes from a global or Europe, Australasia and Far East allocation,” said Andy Barber, partner and technical leader of Mercer Investments in London. “It depends on the governance budget, but it is a lot easier to go outside the U.S. with a global mandate, rather than with various regional briefs.”

The $188.3 billion California State Teachers' Retirement System, West Sacramento, is the only U.S. pension fund of several contacted by Pensions & Investments that has a Europe-specific allocation — although that is going down.

“Our exposure to Europe-specific mandates has decreased over time, but it was not due to our conviction in our European managers,” spokesman Ricardo Duran said in an e-mail. As of Sept. 30, the pension fund had about $1.6 billion invested in Europe-specific allocations.

Europe's potential

The issue of specific allocation aside, some money managers say conviction in Europe's potential is an issue. “Some of our U.S. clients are quite concerned” about Russell Investments' small overweight to Europe, said Wouter Sturkenboom, European investment strategist at Russell in London. “They feel that the U.S. is doing so much better.”

He said investors “need to be where the situation will be better than expected, where valuations are attractive, and there is upside potential. We feel that is more the case in the eurozone than the U.S.”

The manager's overweight to European equities across its portfolios is at the lowest of four levels, he said, which “does tell you something about the underlying risks.” Russell doesn't manage any Europe-only equity portfolios.

Henderson Global Investors Ltd. is finding the sell to U.S. institutional investors tough. Chuck Thompson, Chicago-based head of North America distribution, thinks uncertainty in the eurozone could be to blame. “Perhaps institutions have been on hold waiting to see what the ECB would do with its approach to quantitative easing, and we would anticipate there may be increased interest forthcoming now that the ECB has made its landmark decision to make asset purchases similar to the Fed.” Henderson has about $25 billion in European equities.

Executives at boutique money manager S.W. Mitchell Capital LLP, which has about $2 billion in European equities, are also finding it difficult, despite significant discounts on Europe stocks over the U.S.

“There is nothing to say that Europe won't recover as well,” said Stuart Mitchell, founder and chief investment officer at the firm in London. “I think it is more that (domestic markets) are performing so well that there is no pressure (on U.S. investors) to change.” He said communication of problems across the eurozone, such as the ongoing crisis in Ukraine and Russia, could also be putting off U.S. investors.

While other managers agree Europe is on the path to recovery, they say it will be a rocky road. “Volatility is much higher now,” said Yoram Lustig, lead fund manager of AXA Investment Managers' Smart Diversified Growth fund, based in London. “A couple of months ago we were talking about volatility being dead, but in September we experienced (it) coming back.”

That is evident, too, in the markets. During the week ended Oct. 10, the Stoxx Europe 600 index fell 4%. France's CAC 40 index dropped 4.9%, Germany's DAX index slipped 4.6% and the FTSE 100 fell 3.4%.

U.S. investors are certainly aware of the issues. CalSTRS' Mr. Duran said the fund's 21 risk-factor review committee — made up of senior investment staff from each asset class and monitors geopolitical risk and implementation of its “21 risk-factor” policy — has been “carefully monitoring the situation in Ukraine (and) CalSTRS' exposure to Russia.” The fund has suspended further purchases of U.S. government-sanctioned entities “while we work with our managers, benchmark providers and other parties to determine a proper course of action.”

Manager conviction

But asset owners could be missing out. Several managers say they are now overweight European equities. That is, of course, all relative — and they say their views are geared in particular toward the U.S. market.

“We are now seeing that the European equities markets are slightly more attractive on a relative basis, while valuations in the U.S. market are a little more expensive,” said Anna Weickart, senior investment consultant for manager research at Towers Watson & Co. in Frankfurt.

The firm “will probably be going out with a bit of a stronger message to clients (in general) about European equities. If you have European equities you might want to retain this exposure, rather than going into U.S. equities,” she said.

Known in investment circles as “Draghinomics,” the ECB's announcements last month relating to its targeted long-term refinancing operation — an asset-backed security and covered bond-buying program, and the potential for, or rather no ruling out of, quantitative easing in Europe have all refocused managers' attention on the case for the continent.

“So far, Draghi has done everything right,” said Talib Sheikh, referring to Mario Draghi, president of the ECB. Mr. Sheikh, a portfolio manager in J.P. Morgan Asset Management (JPM)'s global multiasset group in London, added: “He has stabilized the bond market (and) slowly coaxed politicians to make structural changes. ... We have upgraded our assessment of the attractiveness of Europe as an investment destination.”

Mr. Sheikh believes the ECB will inject greater levels of liquidity into the market, and that, in turn, will have a “positive effect on risk assets in the region, which is good enough for me.” JPMAM has e1.2 billion ($1.5 billion) of European equities under management.

And while weak economic data releases, scant detail on the ECB's plans and geopolitical risk continue to weigh on investors' minds, managers can still exploit weaknesses and create opportunities.

Mr. Draghi's announcement was followed by a crisis in Portugal's banking system and an intensified situation in Russia and Ukraine with the shooting down of Malaysian Airlines flight MH-17. “These things do tend to be buying opportunities. Morality and financial markets do not mix,” said Mr. Sturkenboom.

Other managers are not so convinced. Mark Denham, European equities fund manager at Aviva Investors in London, said Europe does not feel particularly cheap, and that earnings need to come through “to justify the current levels.” And Johanna Kyrklund, Schroder Investment Management Ltd.'s head of multiasset investments in London, said the 271.5 billion ($436.1 billion) manager is “neutral Europe.” n

This article originally appeared in the October 13, 2014 print issue as, "U.S. investors not buying European equity pitch".