Despite a modestly positive outcome overall, European equity markets in 2014 certainly didn’t enjoy a record year in terms of returns. The economy, and corporate earnings, disappointed prior expectations, with the slowdown in global growth a particular headwind given the few internal drivers of growth within Europe. The ongoing conflict in Ukraine has continued to give cause for concern alongside the recent Greek bail-out impasse, and these issues have all highlighted the fragile nature of Europe’s recovery, with many headwinds remaining as we move further into 2015.
The utilities sector was the best performing area of the market over 2014 as a whole. Much of the sector’s gains came early in the year as the hunt for yield persisted and low interest rates continued to force investors into equities. The story was comparable for consumer staples, which also outperformed the wider Europe ex-UK market.
The telecoms sector provided a similar level of returns to utilities in 2014, although much of this came later in the year. In recent conversations with a number of European-equity fund managers, they have noted that companies in the sector are set to benefit from a better operating environment, with the potential to improve their top lines through their 4G offerings at the same time as their capital expenditure has stabilised.
There is also the more benign regulatory environment and consolidation story to consider. The telecoms allocation of the average fund in the Morningstar Europe ex-UK Large-Cap Equity category has recently moved from a long-standing underweight to near-parity versus the MSCI Europe ex-UK index.
Unsurprisingly, the worst performing sector in 2014 was energy. The sector’s 20% fall in the fourth quarter of the year left it down 11.5% in absolute terms for the year overall. The average fund in the Morningstar Europe ex-UK Large-Cap Equity category has been underweight in energy for the past two years, so will have benefitted in relative performance terms from this sector allocation effect. However, with the smaller names generally having fared much worse than the large integrated oil companies, the total effect from funds’ energy investments will have depended on their company-specific exposure within the sector.
Despite the headwinds currently faced by the European economy, there are also some positive factors to consider in the outlook for the markets this year. European equities generally have experienced a very positive start to 2015 – the MSCI Europe ex-UK index return of 7.7% (in euro terms) in January exceeded the 6.4% return in 2014 as a whole – as the much-anticipated programme of quantitative easing (QE) was announced by the European Central Bank.
The positive eurozone GDP growth surprise in early February provided further support for European stock markets.
The more upbeat output numbers were led by that familiar economic powerhouse, Germany, whose economy grew by 0.7% in the fourth quarter of 2014. This helped the German DAX index to an all-time high of just over 11,000 during intra-day trading on Friday 13th February.
In addition to QE, there are other tailwinds to bear in mind. The euro’s depreciation is likely to help the recovery to gain some traction, together with the lower oil price supporting stronger domestic demand. In the last quarter of 2014, consumer spending rose at a 2.0% annualised rate. There have also been recent falls in unemployment in Germany, as well as improvements in consumer confidence indicators across the continent.
This has benefitted the consumer staples and discretionary sectors, which were amongst the best performing areas of the European market in January, with the “staples” and “discretionary” tags mattering little for investors who have noted that consumer spending has been rising.
A number of European fund managers have sought to increase their exposure to this consumer spending. This has not always necessarily been implemented via direct channels like retailers, for example, due to managers’ awareness of valuations in that space. Some managers have instead employed more indirect plays, such as increasing their exposure to real estate, where quantitative easing will also be beneficial in terms of yield, or investing in media companies, which could be set to benefit from an increased advertising outlay by firms looking to capture consumers’ discretionary spend.
The average fund in the IMA Europe ex-UK sector mildly underperformed the MSCI Europe ex-UK index in 2014, by around 35 basis points, following two successive years of outperformance by the average fund. There was little difference in terms of returns over the year as a whole when comparing funds by their market-cap focus, with the average fund in the Morningstar Europe ex-UK Large-Cap Equity category returning 6.2% compared to 6.4% for the Small/Mid-Cap Equity category average.
For investors looking to gain exposure to Continental Europe via an active manager, there are a number of strong funds to choose from that are rated by the analyst team at Morningstar, including BGF Euro-Markets, Henderson Gartmore Continental European, and JOHCM Continental European.
Best-Performing Funds
The T. Rowe Price European ex-UK Equity fund has a Morningstar Analyst Rating of Bronze. Its manager, Dean Tenerelli, began running the fund in 2009, but his track record on the pan-European US mutual fund dates back to 2005. He seeks to invest in companies with strong balance sheets, sustainable profitability, and superior cash-flow profiles. The manager can call on the support of T. Rowe Price’s sizeable analyst team for investment ideas, as necessary.
The Henderson Gartmore Continental European fund benefits from a highly experienced and talented manager. John Bennett built a strong track record at GAM before taking over this fund in February 2010. He takes a high conviction approach and the portfolio is characterised by large stock, sector and country bets. The fund has a Morningstar Analyst Rating of Bronze.
The JPM Euroland Dynamic fund is managed by the Dynamic team at JPMorgan led by Jonathan Ingram. The approach focuses on three primary factors: momentum (both price and earnings), value, and quality. The process also draws on JPMorgan’s behavioural finance model with the intention of capitalising on investors’ behavioural biases. The strategy is the same as that applied to three other European funds run by this team, which are rated Bronze by the Morningstar analyst team.
