December-January 2013

EUROPEAN EQUITIES: The ship has come in

ShipInvestors are getting more open-minded about European equities, fund managers tell Fiona Rintoul. Things could only get better for European equities. And they have. But not by much. “There’s no one left to sell,” jokes Daniel Hemmant, senior portfolio manager, European equities, at BNP Paribas Investment Partners (BNPP IP). The flow numbers for European equity funds make grim reading. Lipper statistics for European equity funds registered in Europe show outflows of €7 billion in the first nine months of 2012, €20 billion in 2011 and €15 billion in 2010. It’s small beer compared to the €45 billion ditched by European equity funds in 2008, but that, one imagines, is scant consolation. So, is there light at the end of the tunnel for the asset class? In terms of attracting investors back to European equities, recent figures provide some modest reasons to be cheerful. The bulk of this year’s outflows were in the first two quarters, according to Lipper statistics. July saw tiny inflows, August subdued outflows and September really quite substantial inflows of €3 billion. Does this marginal upturn in the numbers presage a timid return to European equities? Maybe institutional investors, whose equity exposure in general is, as we all know, at an all-time low, are becoming – how to put it? – less completely uninterested. “Attitudes have definitely thawed over the past three months,” says Hemmant. “People are much more open-minded about European equities.” That thaw is partly down to Europe appearing to be less risky than it did earlier in 2012. And that’s mainly the case because the eurozone crisis has been, if not solved, at least very extensively mitigated by the actions of European Central Bank (ECB) president, Mario Draghi. “In July, the risk of the euro falling apart was taken away,” says Mark Glazener, head of global equities at Robeco. “The crisis is not over, but there are a lot more instruments to solve the issues. Even if Greece were to leave the eurozone, which might lead to a bank run in Italy and Spain, the ECB has instruments to counteract that.” Action has also been taken at the national level. Diego Franzin, head of equity at Pioneer Investments, cites the example of Italy. “Structural reforms are happening under the Monti government – things that will bring benefits over the next few years. And from the point of view of the population, there is a realisation that reform is needed.” Valuations in Europe are also compelling. “There are lots of data showing Europe is the cheapest it’s been in three decades,” says Tim Stevenson, director of European specialist equities at Henderson Global Investors, “and European companies are much better managed than they were back then.” There is perhaps also a kind of crisis fatigue at play. Over the past three to four years, markets have become much more familiar with extreme events. Investors have learned to live with such events and are reacting less, suggests Romain Boscher, head of equities at Amundi. “People must invest somewhere, especially in a zero interest rate environment,” he says. “There are good reasons to reconsider the equity case.” And, indeed, those who are, as Boscher puts it “starving for yield” may be tempted by equities. But equity fund managers, trained to pick out good companies, don’t necessarily want to be second guessing politicians and technocrats – neither will they necessarily be any good at this. How possible is it, then, to manage European equities the old-fashioned way in today’s environment? WILLINGNESS
Now that the risk of the euro breaking up has been taken off the table, as far as markets are concerned, by the ECB making clear its “willingness to do whatever it takes”, fund managers can get back to stock selection, suggests BNPP IP’s Daniel Hemmant. “We try to make sure our portfolios are not driven by macro,” he says. The European sovereign debt crisis obviously trundles on, but “the debt side only affects those who hold it: eurozone banks such as Santander and BBVA,” says Hemmant. “They make up 6% of the MSCI Europe index. That’s where the pressure point is.” But other managers feel the eurozone crisis necessitates a country-by-country approach not required before. The performance of the different markets has been very varied, notes Boscher. In fact, the gap is wider than at any time since the creation of the euro. “It’s not by chance,” he says. “Until recently, we were tempted to focus on a sector approach. Now it’s also important to pay attention to the geographic breakdown.” That’s not to say that you can’t find a good company listed in Portugal. But, says Boscher, “even in the eurozone currency risk was implicitly considered.” Some managers are staying away from troubled southern Europe altogether. One is Robeco. “We have no exposure to Spain, Italy or Greece,” says Glazener. “We concentrate on Germany, the Netherlands and France.” Glazener is also overweight non-eurozone countries such as the UK. “Because of the turmoil Europe was sold indiscrimately,” he says. “All the non-eurozone countries went with it. We can buy there at a better price than in international counterparts. For example, UK banks are better priced than US banks.” However, some investors take a different view and prefer not to lump all the problematic countries in together. Franzin finds plenty of good companies in Ireland, for example. “Top-down Ireland is a problem,” he says. “But bottom-up we find some good equity stories.” And Boscher prefers the eurozone to Europe ex-EMU and doesn’t understand why the market is so scared of Italy. “They are doing a great job of reforming the business environment,” he says. The Irish companies that Franzin favours benefit from international exposure, and this is illustrative. In Europe at the moment international exposure is usually a factor for what Stevenson describes as “quality, reliable companies that will outperform”. That’s only logical, since, as Boscher notes, “one hundred per cent of growth must come from somewhere other than Europe”, as eurozone expected growth is zero for 2013. Earlier this year, exposure to emerging markets was a strong theme but that is perhaps less dominant now. “Now the US market, where we saw signs of recovery, is important as well,” says Franzin. UNCERTAINTIES
Overall, it’s very much a question of looking for pockets for value. The days of high growth are gone and not likely to return any time soon. “We started a new period in 2007/8,” says Boscher. “Now the deleveraging story is all but over, but we’re not expecting very high growth potential. The markets and economies in Europe now have to deal with higher risk and lower returns.” He also suggests that volatility is probably too low at the moment. “There are still many uncertainties. Over the past two months, there has been a bullish trend but volumes were low. The bullish trend is therefore fragile.” There could be plenty of problems still to come. Thus, the best that can be hoped for is perhaps what Franzin calls “marginal increments”. A marginal increment of improvement may, for example, be expected in 2013. If 2012 was the peak of austerity, 2013 could bring some relief. For Franzin, one way to maximise performance in this environment is to have a two-pronged strategy. This involves having one part of the portfolio that focuses on core investments – companies that have a good business model that will succeed pretty much no matter what – and one part that is more opportunistic. Opportunistic investments are ones that depend not solely on a company’s fundamentals, but on some other contingency. For example, whether you believe the ECB’s euro rescue plan will work. “In the summer, when Draghi said the ECB would do what it had to do, a part of the equity universe that had not been investable before became investable,” says Franzin. “For example, companies with high leverage.” To take advantage of these kinds of tactical investment trends, you have to be fleet of foot. “You have to be invested in that segment before the announcement,” says Frazin. It’s hard, then, for investors in European equities to get away from watching the politicians. And, as Stevenson reminds us, while the ECB’s summer action may have chased away the spectre of a euro break-up in the short term, it also means that: “We’re sentencing ourselves to the world we’ve been in for longer.” Or another way: we’re borrowing from future potential growth. Which is how we got into this mess in the first place. ©2012 funds europe

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