While many are looking forward to the Eurovision Song Contest this weekend, few people are so positively inclined towards European investments. European equity markets have scored null points from investors over recent months, as shown in the charts below.
The first chart shows the discrete monthly flows out of European equity funds over time, and the second shows the relative attractiveness of the leading benchmark — the MSCI Europe — on a variety of valuation measures.
Both charts tell a similar story. As an asset class, European equities have rarely been so cheap and unloved as they are today, with outflows almost at peak.
This is surprising, when the yield on equities is significantly in excess to government bonds. With this in mind, perhaps investors will reappraise the situation later this year and begin “making their mind up” to start allocating capital again.
However, while European equities are currently judged low in the rankings, some European stock markets have performed very well so far this year and a number of funds have strongly outperformed the index.
For example, the MSCI Europe (excluding UK) index had risen 15 per cent to the end of April. The question is, what has been driving the returns of the more successful funds? This will determine whether they ride up the charts in future, or are merely a one-hit wonder.
The X factor
When judging investment performance, the most important factor has been how exposed fund managers have been to stocks that fall under the growth/quality category, compared to those investment managers would classify as value stocks.
In simple terms, the former group tend to have superior profit growth, whilst the latter tend to be cheaper. Both these styles of investing have periods when they will outperform the market and equally times when they will underperform, yet the period of underperformance of value stocks has rarely been so extreme or prolonged. This is shown in the chart below, where we can see that the valuation of value stocks relative to that of growth stocks has rarely fallen as far as today’s low.
It is no surprise that European funds which are focused on quality names and include stocks that exhibit growth characteristics have performed the best this year. Having scant exposure to banks — a significant component of the value grouping — has been especially important.
While I like several funds that adopt a value investing style, such as the Invesco European Equity Fund, they will not be winning this year’s top prize. Of course, past performance is not a reliable guide for predicting future success and so investors have to assess contenders on a variety of attributes. Colourful outfits, exuberant hairstyles and show-stopping dance routines cut no ice, but the strengths of the management team, the firm they work for and their investment philosophy and process are where points are awarded.
Fund management is a people business. When my team assesses suitable fund choices for our clients, we like to see experience and humility in the investing team. A winning strategy is certainly not just about qualifications or the size of the team. We try to allocate investment exposure to teams with a low turnover of managers and that have weathered a variety of market conditions. Even the strongest of teams would be severely hampered by working in an environment that is not conducive. Asset management firms score highly if they have a supportive culture, as well as a robust financial position.
That said, management teams must be seeking to exploit a clear market inefficiency and have a framework that is set up with this in mind. Investors will want to see a robust and repeatable process spanning idea generation, research notes, risk control, and portfolio construction. A clear “sell” discipline and an awareness of investing sustainably is also vital. With all of this in mind, I have selected three contenders vying to win this year’s European fund contest that investors seeking European exposure may wish to consider.
10 out of 10 for Germany
Always a safe Eurovision bet, Germany is also home to the fund management team that has performed among the very best year-to-date — the Allianz Continental Europe Equity fund. By focusing on growth sectors it has returned more than 20 per cent for its investors this year, with an underweight to financials and an overweight to technology stocks being key performance drivers.
Lead portfolio manager Thorsten Winkelmann will have been at the helm in Frankfurt for a decade this autumn — a heritage leadership that is clearly paying dividends.
One for Blighty
Another one to watch is the Jupiter European fund — based in London. It has been very successfully managed by Alexander Darwell for more than 15 years, being one of the best performers over that entire period. However, it has recently been announced that this is his swansong and he will shortly be stepping back from the fund. Mr Darwell’s successor, Mark Nichols, is currently on gardening leave from Threadneedle, his previous employer — something investors should be aware of before casting their final vote. Just as in Eurovision, the UK entrant is this year’s underdog.
Also vying for the title is the BlackRock European Dynamic fund. If Australia and Israel can now compete in Eurovision, surely we can bend the rules for a US firm — especially when its team is mostly based in Edinburgh.
This contender has also returned more than 20 per cent to investors this year, a strong performance that could be attributed to the enthusiasm and experience of the lead portfolio manager, Alister Hibbert, supported by a very seasoned and sizeable research team. I hold this fund in my personal investment portfolio. There have been some outstanding stockpicks of late, such as Ferrari, Airbus and LVMH, all up over 40 per cent so far in 2019, giving this entry all the makings of a showstopper.
While the winner of the song contest will be revealed on Saturday night, investors should remember that judging the investment performance of European funds is a long-term game. If you’re unsure how to pick a winner, seek professional investment advice.
Ian Aylward is head of fund selection at Barclays Wealth and Investment. The views expressed are personal and do not constitute an investment recommendation