European shares are fast becoming a favourite among professional investors, as economic recovery gathers momentum and companies upgrade their earnings forecasts after years in the doldrums.
Europe is currently wealth manager 7IM’s highest overweight equity position, while FundCalibre, the fund ratings provider, is more positive on Europe than on any other developed market.
In September the European Central Bank (ECB) raised its 2017 growth forecasts – from 1.9% to 2.2% – after the eurozone economy registered its best growth run in a decade.
“Five years after [ECB president Mario] Draghi promised he’d do “whatever it takes”, the economy is showing signs of good health,” says Tony Yousefian, FundCalibre’s investment trust research specialist.
“Inflation has been in positive territory across the eurozone , employment stats are improving, rising GDP growth is forecast and in the March reporting season a slew of companies posted earnings upgrades after several years of flat (at best) corporate profits.”
A string of other positive news – Greece, Spain, Italy and Ireland are showing strong signs of recovery, while Portugal has had its debt upgraded – has also contributed to a shift in investor sentiment.
“This has led to substantial inflows and driven momentum within the region, which has been a big driver of performance,” says Anna Sofat, founder of London-based Addidi Wealth.
European shares are no longer the bargain they were a year ago, but valuations remain relatively more appealing. As at 21 September, the Stoxx Europe 600 index has rallied 25.8% from a February 2016 low, with much of that growth coming in the first half of 2017.
However, price/earnings (PE) ratios show that there is still value in the sector: while European shares are trading on multiples of 15 times projected 12-month forward earnings, US shares are more expensive on multiples of 18.2 times, according to 7IM.
Senior investment manager Damian Barry says: “At a time when valuations look stretched in some markets, European profitability and returns still have a lot of upside and are well behind levels enjoyed in the 1990s and the noughties.”
Sofat believes that European equities will continue to perform well despite the ‘cloud’ of Brexit hanging over the region, thanks to the lower multiples on which they trade. We turn the spotlight on three trusts that invest in Europe, but do something a little differently from conventional equity trusts.
European Assets Trust (EAT), a Money Observer Rated Fund, focuses on small and medium sized companies listed in Europe, and has a high distribution policy: it pays out 6% of its year-end net asset value annually to shareholders, funding this partially from capital reserves.
Manager Sam Cosh, of F&C Asset Management, takes a high-conviction, long-term approach, which results in a relatively concentrated portfolio of about 40 companies and low portfolio turnover.
“Stock selection will be the greatest determinant of performance, and we select stocks using proprietary in-house fundamental research,” he says.
“The bias is on buying high-quality businesses, which means companies that can generate high future return on capital on a sustained basis. These companies must have wide “moats” that protect them from competition and therefore protect their profits. We will, however, avoid paying too much for these companies and invest with a margin of safety.”
Given how expensive high-quality companies are at the moment, Cosh has “tried hard” to build a well-balanced portfolio where quality is also supported by valuation.
“This means, for example, that we have some significant holdings in the financial sector, which is now beginning to show earnings leadership yet is still attractively valued,” he says.
“We have also found interesting opportunities in areas of the market which have, until now, lagged the European earnings recovery, such as Italian and Spanish smaller companies.”
Cosh sees smaller companies as being best placed to benefit from the European recovery that is gathering pace.
Brighton-based Skerritts Wealth Management has held European Assets in its model portfolios for the past four years on the strength of its exposure to smaller companies.
Head of investments Andrew Merricks says: “We prefer trusts that focus upon smaller and medium-sized companies for longer-term growth, because large-cap geographic trusts tend to move more in line with their underlying currencies than on other factors. Small and medium-sized companies are better barometers of the domestic picture, and the domestic picture across Europe has been improving.”
Merricks also likes the “quirky” dividend payment. “It [the trust] is not in our income portfolios as the dividend is only paid annually, but even within a growth mandate a dividend of around 5-6% is a very useful addition to overall returns.”
BlackRock Greater Europe
While the majority of shareholders’ capital is invested in ‘best in class’ assets in developed Europe, BlackRock Greater Europe (BRGE) also has the ability to invest up to 25% in emerging Europe from a risk perspective.
Co-managers Stefan Gries and Sam Vecht are currently employing the maximum allocation after the region experienced a ‘lost decade’ in terms of share price performance.
“We are optimistic on the outlook for both developed and emerging European equities, not least because we are facing the best earnings outlook in a decade,” says Gries.
“With subsiding political risk across the eurozone, investors have started to allocate capital back to the region.”
The managers seek to build a focused portfolio of 35-45 stocks from an investable universe of more than 2,000 companies, with the aim of delivering capital growth.
Their research process includes conducting more than 1,300 company meetings per year as they look to unearth the best ideas across Europe.
Their approach is unconstrained, with no systematic biases to style or market cap.
Recent stockpicking has led them to be overweight sectors exposed to the domestic European recovery, with their largest positions being in industrials, construction, technology and consumer discretionary stocks.
Sofat believes that the trust offers an “interesting play” on emerging European markets. Its defensive nature alongside its current discount of 3.9% make it an “attractive”investment proposition.
Although longer-term performance has been disappointing, recent returns have stacked up well versus competitors.
“Performance has been good if not eye-catching and the new co-manager Stefan Gries, who took over in June 2017, will clearly be keen to make his mark alongside the well-rated Sam Vecht,” says John Newlands, founder of Newlands Fund Research.
JPMorgan European (JETI) is relatively unconventional, in having two share classes to suit investors looking for either income or growth and offering the ability to switch between them without crystallising a potential capital gain.
It is, however, not a split capital trust: there are two distinct portfolios, one focused on growth companies and the other on higher-yielding shares. Both are extremely well-diversified; the growth trust has 168 holdings and the income trust, a Money Observer Rated Fund, has 223 positions.
The income portfolio has significant exposure to financials – 37% compared to 25% for the JP Morgan European IT Growth (JETG) portfolio. Other major differences are in healthcare (10% of the growth portfolio and 3.6% of the income) and technology (9.2% of growth and 2.8% of income).
Speaking of the income shares, co-manager Stephen Macklow-Smith says: “We can still find lots of higher-yielding stocks with defendable dividends in financials, especially banks and real estate, and more selectively among insurers. We are underweight in healthcare since most stocks do not yield enough to qualify for inclusion.”
He expects company earnings in Europe, now in its 18th quarter of economic recovery, to grow by a double-digit rate both this year and next – and to lead to rising dividend payments. “We are expecting to see growth in dividends among our universe of companies since balance sheets look healthy,” he says.
Investor demand for income means that these shares trade on a narrower discount – 5.7% as opposed to 9.3% for the growth trust.
The ability to switch between the portfolios free of tax make them an ‘interesting play’ if a client’s need for growth or income changes, says Sofat at Addidi Wealth. However, she notes that the attractiveness of this trade would depend on the respective discounts at the time.
Newlands hails both components as “unsung heroes” of the investment trust sector.
“Either would deserve a place in a diversified portfolio of trusts held by the relatively risk-averse equity investor,” he says.
“Unless income is a particular requirement, I’d favour the growth pool at the moment as it is slightly larger and more liquid and stands at a more attractive discount.”
JP Morgan European IT Growth
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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.