Should Investors Stay Underweight Europe? Three Reasons Why It’s Time to Reconsider That View Now
After a decade encompassing Brexit and the euro crisis, and amid disappointing returns relative to other markets, many investors have written off European equities, but River and Mercantile’s James Sym believes that stance now needs to change.
Investors underweighting European equities now run the risk of missing the recovery in the region, according to Sym, manager of the recently launched ES R&M European Fund, with the continent offering attractive valuations, a leading position in up and coming sectors, and political unity.
Europe’s major equity indices have lagged the US and other regions so far this year, with the double-digit gains seen in some US markets far ahead of country-specific and broad indices on the continent.
However Sym, who joined River and Mercantile this year, says this disparity has created a glaring opportunity for investors.
“European equities have been unloved and under-owned since last year, with August the first month that investors started to return to the asset class[1],” he says. “Turning points are often the best moments for relative returns – but it is critical to position ahead of that.”
Below, Sym outlines three factors as to why investors should be reconsidering their European exposure now.
1. A better crisis
The time to own European assets is when the region is making top down political progress towards convergence. That was true with the establishment of the euro in the cycle from 2002, it was true post “do whatever it takes”, and it is true today.
In some ways Europe needs a crisis to spur it into action. For years it has been obvious that for the euro to be sustainable there needs to be balance sheet mutualisation across Europe and fiscal transfers. The coronavirus crisis has finally catalysed this move, which should serve to bring the cost of capital down for unloved companies across the continent.
Under the recovery fund plans, the European Commission is likely to become one of the biggest AAA-rated bond issuers in the world. The initial issue was 14 times oversubscribed[2]. This gives the periphery access to capital markets under the same terms as Germany or the Netherlands. Additionally, the net effect of the grant element of the structure is that German taxpayers are paying for peripheral infrastructure investment. This should bring down the risk premium for the region and be good for growth.
2. Leading position in ESG
“In a post-Covid environment, the world is coming Europe’s way. Simply put, European stakeholder capitalism was never the ideal light-touch regulatory environment which big tech needed to thrive. This has been a big drag for equity returns as the FANG phenomenon drove US equity returns. However, pre-eminent themes for the next cycle, such as energy transition, are areas in which Europe excels and it has companies well placed to deliver this. Meanwhile, the regulatory noose is starting to circle some of the large US technology companies. At the very least it should be, or become, a more level playing field.
3. Unloved stocks
“With outflows for most of the last year, many investors find themselves underweight the region now, while index levels remain far below their highs – unlike other regions, such as the US.
“Year-to-date, the MSCI Europe index is down 14%, while the MSCI World is up 3%[3]. There is a relative valuation opportunity, and it looks even more attractive if you drill down further.
“The landscape in Europe is one that is full of growth funds which are (clearly) full of growth stocks which have outperformed. But if you look elsewhere, there are some really attractive opportunities that offer investors a great chance to take part in an economic recovery post the Covid disruption.
“While interest rates stay low, government spending stays high. We now see the mechanism for populism to ultimately lead to inflationary outcomes which if it transpires would set up a potentially difficult market for many clients.”
[1] According to Calastone research, as quoted by Investment Week
[2] https://ec.europa.eu/commission/presscorner/detail/en/IP_20_1954
[3] According to Bloomberg data, to 22nd October
