Ask the Investment Team
Exploring investment opportunities in Europe
5 min read
Our April Ask the Investment Team client call explored the investment landscape in Europe and opportunities across the region. Despite upcoming elections in France and Germany, Europe appears to be experiencing a sustained resurgence. How can we find investment opportunities and mitigate against potential political risk?
This month’s investment experts were two of our senior portfolio managers, Monique Wong and Simon Pinckney. They were joined by Nick Williams, Head of the Small Cap Equities Team at Barings, and manager of the Barings Europe Select Fund in which Coutts invests. The call was hosted by Paul Sarosy, Head of Client Investment Management. Following are the main points of their initial discussion followed by client questions.
Monique Wong: We’re in a sweet spot for investment markets. On the macroeconomic side, we have synchronised global growth. Since the middle of last year, we’ve seen the US growing and possibly at full employment; Europe, led by Germany, exhibiting an increasingly sustained uptick; and emerging economies coming out of recession. We have inflation normalising in the developed world and coming down from very high levels in the emerging world. We’ve had company earnings growing across all regions and broadly across all sectors. In Europe, they’ve been growing for the first time in five years.
Simon Pinckney: In a typical balanced portfolio, we would have around 50% in invested in equities and of that, 6–7% would sit in European equities. For diversification, we would hold either direct stocks, third-party funds such as Nick’s [Barings Europe Select Fund] or passive investments such as exchange-traded funds. Nick’s fund would comprise about 1.5% of a portfolio – a material portion of our European exposure.
Nick Williams: The Barings Europe Select Fund invests in smaller European companies with a market capitalisation of less than €5 billion at the time we purchase them. Smaller companies have been very strong performers despite political and economic challenges. Over the past five years to the end of March, small companies have outperformed large companies by about 5% a year and the return is almost 17% a year in sterling terms. There are a lot of interesting companies in Europe and because the region has been out of favour for so long, new companies have traded at lower valuations than might be expected.
We seem to be seeing economic growth in Germany and Northern Europe but less so in Southern Europe. Do you see this imbalance as a problem?
Monique Wong: Unevenness of growth is a characteristic of the eurozone and these are not convergent economies. However, at the macroeconomic level economic data is improving despite idiosyncrasies such as Italy, which is seeing a cyclical recovery and needs more structural reform in the long term. Broadly, the direction of travel is positive. In terms of the north–south divide, I don’t think that’s always true. In 2016, Spain had no government for most of the year but it was the fastest-growing economy of the ‘big five’. It has been the quiet outperformer so far this year, up 12% year to date versus 6–7% in Europe overall.
Where does the Barings Europe Select Fund find opportunities?
Nick Williams: The country we have most exposure to today is France. Some people believe France may be vulnerable to political risk, so you can achieve exposure to French companies at a relatively low valuation. Some of those companies often have very little to do with France but are simply based in the country. For example, one of our biggest holdings is a call centre operator based in France but it conducts most of its business in the English-speaking world. This is a clear example of how we can use negative sentiment to identify opportunities on a bottom-up basis.
Where do we see sterling in relation to the euro considering the French election and other events?
Simon Pinckney: We look at portfolio growth in an international context and don’t think an election result is likely to have a material impact on global trade. We think the results of the French and German elections will be irrelevant if you look at Trump’s election victory and the Brexit vote as comparisons. We believe sterling is cheap and undervalued. It’s fallen since the Brexit vote by about 20%. It’s down to a 30-year low against the dollar and trading towards the bottom of its range against the euro. Looking forward, we think sterling will appreciate.
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Do you think that the ‘sweet spot’ has already been priced in due to both equities and bonds being overvalued? Is this a cause for concern?
Monique Wong: We’re trying to identify regions where valuations are more attractive to us and gauge how long this sweet spot will last. Bonds are expensive due to low interest rates in the developed world (the lower the interest rate, the higher the price of the underlying bond), while some equity markets are more expensive than we usually expect them to be, particularly in the US. There is no evidence to suggest a slowdown or imminent recession, but it’s something we are constantly monitoring.
Simon Pinckney: We are trying to pick quality assets for long-term returns. The US equity market has hit an all-time high for each of the past six or seven years and it keeps growing. Our aim is to be invested in the long term, select quality assets and be diversified to mitigate risk.
Nick Williams: We think smaller companies offer different characteristics to larger companies. They have their risks but they also offer better longer-term returns. In terms of how we choose stocks, it’s very similar to how Coutts selects asset classes. We are looking for quality, long-term growth potential at a sensible valuation.
In terms of investment inflows, have you seen data that is typically earmarked for the US coming to Europe?
Monique Wong: There are early indications that there have been some investment inflows from the US into Europe but it has been within the speculative space, such as hedge funds. In terms of real money, there haven’t been huge flows into Europe largely because the US is a much easier story, with Trump coming into power and his rhetoric of tax reforms and lighter regulations. When you look at Europe, there are elections on the horizon. Once the French elections have passed, polls suggest we could see more international flows come in to Europe.
Do the elections play a part in the stock selection process undertaken by the Barings Europe Select Fund?
Nick Williams: We think about elections in terms of risk but what most important to us are the opportunities at the stock-specific level. One of our biggest weightings is to Italy. The Italian economy has been weak for 10 years, but you can find a lot of interesting companies that have managed to grow consistently within the country. If you invest in a well-run company that has a strong balance sheet, it should be able to grow despite domestic issues.
Coutts April Ask the Investment Team client call explores investment opportunities in Europe and how to mitigate political risk to achieve long-term returns.
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