Why this unloved fund sector is topping the performance charts

Over the past year funds that invest in this region have consistently had money withdrawn, despite performance beating many other fund types. Kyle Caldwell explains why.

Over multiple time periods funds that invest in European shares have been towards the top of the performance charts, but despite this appetite amongst investors remains low.

As research by interactive investor shows European fund sectors have performed well over four different time periods – six months, one year, three and five years. In particular, the performance of European funds that can invest in shares of any size has impressed out of all the 58 fund sectors. The data was sourced from FE Fundinfo. 

However, investor demand for such funds is notably lacking. Figures from the fund industry trade body, the Investment Association, shows that all three European fund sectors have seen more money withdrawn than invested every month over the past year.

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Low sentiment leads to low valuations

So what have been the reasons behind performance being ahead of the majority of other sectors?

The first thing to point out is that European stocks have been unloved for many years, and investor sentiment was not helped by Russia’s invasion of Ukraine last February.

In addition, there was a negative economic outlook to Europe due to high energy prices. However, last winter turned out to be mild, which averted a potential power crisis. 

As a result of low sentiment, European shares carry low valuations, particularly compared to the US markets, which are much more tech-heavy.

Therefore, as there was a lot of bad news priced in and low expectations, there was plenty of upside potential.

Source: FE Fundinfo. Data to 16 May 2023. 

Why European shares have been in good form  

One of the main drivers has been the change in the macroeconomic landscape, which has seen interest rates rise sharply. Earlier this month The European Central Bank (ECB) raised interest rates by 0.25 percentage points to 3.25%. In the UK interest rates are at 4.5%, while across the pond US rates are in a range of 5% to 5.25%.

Daniel Babington, portfolio manager at TAM Asset Management, points out this has contributed to a rebound for European markets, due to the continent having a higher weighting to cyclical industries, such as energy and financials.

He says: “The rotation away from growth stocks and large cap tech names in the last 18 months on the back of interest rate increases has been a boon for the more conservatively valued and cyclical nature of the European stock market.

“After record outflows from European equity markets last year, pockets of value began to emerge that were perhaps – upon considering valuation – more suitable to a higher rate environment than other parts of the global market.”

Another positive has been the re-opening of China, which has boosted sales for Europe’s luxury goods companies. These companies have also benefited from the resilience of spending power amongst wealthy consumers against the cost-of-living crisis.

Among the winners has been LVMH Moet Hennessy Louis Vuitton SE (EURONEXT:MC), made up of fashion brand Louis Vuitton and drinks companies Moët and Hennessy. The firm recently became Europe’s largest publicly traded company.

Other European listed luxury goods stocks that have benefited include Hermes International SA (EURONEXT:RMS), Kering SA (EURONEXT:KER), Moncler SpA (MTA:MONC) and Prada SpA (SEHK:1913).  

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Tom Becket, of Canaccord Genuity Wealth Management, notes that due to some of its leading companies being luxury goods companies “investing in Europe is a way of playing an emerging market recovery led by China.”

Babington adds that as European stocks were trading at record discounts to the US earlier this year “any sustained positive sentiment was likely to ignite a rebound”.

As well as housing luxury goods companies, Europe also has global leading businesses in healthcare.

Charles-Henry Monchau, chief investment officer of Bank Syz, points to the GRANOLAS, an acronym coined a couple of years ago by Goldman Sachs to highlight the star stocks in Europe. It stands for GSK (LSE:GSK), Roche Holding AG (SIX:ROG), ASML Holding NV (EURONEXT:ASML), Nestle SA (SIX:NESN),Novartis AG Registered Shares (SIX:NOVN), Novo Nordisk A/S ADR (XETRA:NOVA), L’Oréal (EURONEXT:OR), LVMH Moet Hennessy Louis Vuitton SE (EURONEXT:MC), AstraZeneca (LSE:AZN), SAP SE (XETRA:SAP) and Sanofi SA (EURONEXT:SAN).

He said: “Common features of these companies include relatively strong balance sheets, low volatility growth and good dividend yield. The GRANOLAs dominate the Europe’s  STOXX Europe 600 index and continue to attract foreign flows. This cohort of Europe’s most valuable companies is dominating and now account for more than one fifth of the Stoxx Europe 600 benchmark by value.”

Have investors missed the boat?

When markets are buoyant, and fund performance for a particular region is by extension boosted, there’s always the danger that the ship has sailed.

However, in the case of European equity markets, valuations remain cheap, points out Hilde Jenssen, head of fundamental equities at Nordea Asset Management.

She points out: “Despite the recent outperformance, European equity markets are still trading at near historic discounts relative to the US, with multiples in many sectors remaining well below long-term averages.

“As for longer-term tailwinds, the energy transition spending programmes coming from both sides of the Atlantic will create opportunities for European corporates.”

Babington agrees that plenty of value remains, but sounds a note of caution due to there being “huge economic and geopolitical uncertainty”.

He added: “Looking forward, I think the main call from here is yes, there is a deep level of value and quality to be found in European market, but the next year could prove uncertain with the devastating war in Ukraine and the battle with inflation.”

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European fund, investment trust and ETF ideas

For stock pickers running a European mandate, the region is rich in companies that are global leaders in their fields or niche industries.

Amongst interactive investor’s Super 60 list of fund ideas is BlackRock Continental Europe fund. It yields more than 3%, and invests in quality European companies with sustainable and growing dividends. It has a bias to the healthcare, financial and industrial sectors.

Another Super 60 fund is Janus Henderson European Select Opportunities. Experienced fund manager John Bennett pays close attention to economic and sector trends, positioning the portfolio to reflect his macro views. The fund holds more than the index in industrials, financials, and basic materials.

Also in our Super 60 is Man GLG Continental Eurpean Growth. Fund manager Rory Powe focuses on investing in high quality growth names, seeking to invest in companies that have a competitive edge within their industry. The fund holds notably more in consumer discretionary stocks than the index. In its top 10 positions luxury goods companies LVMH and Moncler feature.

For smaller company exposure our analyst team are fans of The European Smaller Companies Trust (LSE:ESCT). Its fund manager Ollie Beckett runs a highly diversified portfolio – of over 100 stocks – seeking to find companies with exceptional growth potential.

In terms of passive exposure Vanguard FTSE Developed Europe ex UK ETF Dis GBP (LSE:VERX) is the Super 60 option. For a yearly charge is 0.1% this ETF tracks the up and down fortunes of around 450 stocks, providing both large and mid-cap exposure.

For other European passive plays without the UK one route is via passive funds that seeks to replicate the the EURSTOXX 50 index, which features the 50 biggest stocks from the 11 countries in the eurozone – countries that use the euro.The cheapest are HSBC EURO STOXX 50 ETF GBP (LSE:H50E) and Invesco EURO STOXX 50 ETF GBP (LSE:SX5S), both charging just 0.05%. 

Investors who would like some UK exposure in a Europe can obtain this through passive strategies that follow the STOXX Europe 600 index, which holds around a quarter in UK shares. This index is seen a key benchmark of the performance of European shares, representing the 600 largest stocks by market cap across 17 European countries. 

The cheapest way to track this index is with the Lyxor Core STOXX Europe 600(DR) ETF Acc GBP (LSE:MEUD), with an ongoing charge of just 0.07%. There is also the Invesco STOXX Europe 600 ETF GBP (LSE:S600), with an ongoing charge of 0.19% and Xtrackers Stoxx Europe 600 ETF 1C GBP (LSE:XSX6) for 0.21%. 

How the Super 60 funds have fared over multiple time periods 

Source: FE Fundinfo. Data to 16 May 2023.