The successful launch of the economic and monetary union in Europe has confounded skeptics and delighted those who have long taken the view that EMU was inevitable. True, the new single currency, the euro, got off to a shaky start but for the long term there is no turning back on the EMU trail.
Now that the currencies of the 11 participating countries are locked together, it will become increasingly expensive for these countries to withdraw from the system.
For U.S. pension plan sponsors investing in Europe, the implications of EMU are substantial. Since the creation of EMU, stock markets in the EMU countries have not been highly correlated; despite the single currency, differences remain in areas such as labor law and tax structure that might affect companies operating in the same sector.
But as EMU progresses, the importance of country allocation is likely to diminish and U.S.-style stock selection methods within chosen market sectors will become more widespread.
A sector/stock approach to Europe is even more critical because of the changing makeup of its industry and commerce. Traditional, heavy industries are in decline and new growth sectors are emerging, often led by fast-growing midsized companies. The same transformation that has occurred in the United States in the past two decades - away from basic manufacturing toward new technologies - is only just beginning in Europe.
Take biotechnology, a high-growth sector that was dominated until quite recently by the U.S. and the U.K. Some European governments actively discouraged biotech startups on ethical grounds, but this attitude has changed dramatically in the past five years or so. Since 1995, when the German government launched a special initiative to encourage this sector, more than 300 biotech companies have been created. In March the first of these companies, Morphosys, obtained a listing on Germany's Neuer Markt, the Frankfurt market for growth companies.
Other emerging growth sectors in Europe include:
* Telecommunications. Once a staid and slow moving industry, it is now at the forefront of a virtual revolution as new technology and deregulation take hold. New entities are moving to take advantage of the demand for better service and better pricing. Britain's Vodafone has emerged as a strong global player in the cellular phone market with its purchase of AirTouch, creating a pan-European cellular network.
In Germany, despite Deutsche Telekom's aggressive pricing tactics, MobilCom and Teldafax - unknowns just two years ago - have seized one-third of the country's long-distance market. Both have grown at phenomenal speed by focusing exclusively on reselling network capacity.
And across Europe, the business sector of the telecommunications market has been cornered by upstarts such as Energis and TeleWest of the U.K. and Equant of France.
* High-technology. Just as Finland's Nokia has taken a top spot in global markets with its cellular technology, Germany's SAP has done the same with its systems integration software for business. Other companies, like France's Dassault Systemes are taking the lead in design software. As for semiconductor design, STMicroelectronics is typical of Europe's new growth companies. A maker of highly specialized computer chips, it is a Franco-Italian company listed in the Netherlands and on the New York Stock Exchange.
* Contract services. The practice of outsourcing non-strategic corporate functions is becoming more widespread in Europe, opening up opportunities for innovative firms. For example, only 10% to 15% of European companies outsource corporate cafeteria services, compared with 50% to 60% in the U.S.
Firms such as U.K.-based Compass Group or Sodexho of France are growing rapidly on the back of this trend, as are companies specializing in the provision of temporary staff.
* Asset management. The demographics of most European countries indicate an urgent need for pension reform if the demands of an aging population are to be met. Many national pension schemes in mainland Europe are underfunded; Germany, for example, has no more than about $200 billion of funded pension assets for a population one-third the size of the United States, where assets of both defined benefit and defined contribution plans now exceed $6 trillion. Investment management firms like the U.K.'s AMVESCAP and banks such as Julius Baer of Switzerland and Bipop-Carire of Italy are well positioned to take advantage of the inevitable rise in funded pension schemes.
New sources of capital
It's no coincidence that new pockets of capital are opening up to support this growth wave in Europe. According to Merrill Lynch, more than half of Europe's 416 initial public offerings in the first half of this year were originated by companies in the high-tech, high-growth or white-collar service industries, and this trend has been rising for the past five years. Chances are many more of these companies are waiting in the wings.
Germany's Neuer Markt, which will celebrate its third anniversary in March, has proved fertile ground for young, fast-growing companies, especially those in the technology sector. More than 160 such companies are now listed on this relatively new market, and almost one-third of them represent the information technology hardware, software and service sectors. The Internet accounts for another 12%. Fledgling companies in Germany are now gaining access to capital, which in the past was hard if not impossible to find at the country's banks.
Early-stage financing for new growth companies is also becoming more available. According to the European Venture Capital Association, the amount of early-stage technology investment in Europe more than tripled in the five years from 1994 to 1998. The technology sector now accounts for almost 30% of total funds invested by European venture capitalists and last year technology investment jumped by 75%, EVCA figures show.
`New technology' sector
Indeed, some U.S. pension plan sponsors already have taken the private equity route into Europe's "new technology" sector. Earlier this year, Atlas Venture, which operates on both sides of the Atlantic, completed raising a $400 million technology fund that will be invested fairly evenly between the U.S. and Europe in industries such as e-commerce, data and mobile communications, enterprise software, and life sciences. The state pension plans of both Virginia and Pennsylvania are investors in this new fund.
Of course, investors buying publicly traded stocks in Europe need to pay careful attention to valuations, not just growth prospects. The key is to select stocks that offer good, long-term growth in relation to their current value. Because many stocks already discount substantial future growth, investors need to evaluate company prospects in detail. It also helps to diversify investments among large-, medium- and small-cap stocks.
Just as technology stocks in the United States have experienced high price volatility, those in Europe are showing a similar tendency to overshoot near-term investment parameters. Consequently, investors need to pay close attention to their points of entry and exit.