Following strong gains in 2013, European funds have had a very tough time of it this year.
Worryingly low inflation and falling economic growth forecasts on the continent have meant that IMA Europe ex UK has been one of the worst performing sectors in 2014, with the average fund in the sector losing 2 per cent over the last six months while US, Japan and UK funds have all made money.
Performance of sectors over 6 months
Source: FE Analytics
On top of that, more cyclically-orientated funds such as Invesco Perpetual European Opportunities, Neptune European Opportunities and Schroder European Alpha Income have lost more than 7 per cent over that time.
While the likes of FE Alpha Manager David Coombs have described Europe as “an almighty mess” and maintained an underweight position as a result, it is one of the few areas of the market Brookes is confident on going into 2015.
The manager has been upping his Schroder MM range’s exposure to European funds recently and expects to buy even more over the coming months.
“Europe looks fabulous value,” Brookes (pictured) said.
“The premium of the US P/E ratio to the European P/E, in other words how much more expensive the US is towards Europe, has never been so high. Effectively, everyone is super bearish on European equities and I genuinely think they will perform much better than people think.”
“Everyone is convinced that there is going to be a deflationary bust in Europe. I do think that the monetary conditions that existed two years ago determine what happens today and since two years ago, policy in Europe has become easier.”
“The ECB has definitely been expanding its balance sheet and it should be doing more in the new year if Mr Draghi gets what he wants. I think European shares will get the benefit of an economic turn and it will be really, really good.”
Brookes is renowned for making contrarian calls within his portfolios.
These don’t always work, as his very underweight position in bond and US funds has hurt him this year. Nevertheless, this value bias has helped him to considerably outperform his peer group composite since he has run funds of funds in the IMA universe.
Performance of manager vs peer group composite since Oct 2004
Source: FE Analytics
Though many are concerned about the logistics and legality of full-blown QE in Europe, Brookes doesn’t think investors will have to wait long for European equities to rally.
When asked when he expected a turnaround, he answered: “Soon, really soon.”
“Everyone has been saying German manufacturing data has been a bit squishy lately but what people haven’t really said that it wasn’t as squishy as expected. Actually, the number was fine. It wasn’t brilliant, but it was fine.”
“It looks to us that the trough, for the economic cycle, is within months if we get a fairly bullish Q1. The TLTRO [targeted longer-term refinancing operation] is about to happen which means the ECB will expand its balance sheet pretty soon so we are going to get that positive lift of a super cheap currency.”
“There will also be some sort of political willingness to do it because Japan will knick their growth by devaluing their currency and so even the Germans will come round to the idea that, actually, some sort of quantitative easing is the right policy.”
Brookes currently uses the likes of Invesco Perpetual European for his exposure, but suspects he will be buying Philip Wolstencroft’s £250m Artemis European Growth fund to take advantage of the upcoming rally as it has “leverage back into the mean reversion”.
Brookes has used the fund in the past to play a specific role in his portfolios as it has the tendency to shoot the lights out in a rising market, though it has offered very little protection when sentiment has been weak.
“We invested in that fund back when it launched in 2001 and owned it until 2007. We sold it on the basis that it was 40 per cent banks and they were Irish and Greek banks.”
“It then massively underperformed and we bought back in in late 2011 and, again, the forecast was Draghi was about to do ‘whatever it takes’ but we had also seen Europe just start to bottom in terms of recession so it was pretty clear they weren’t going to let any more banks go bust.”
Brookes sold the fund earlier this year on the back of its strong gains in 2013.
According to FE Analytics, Artemis European Growth has been a top decile performer in the IMA Europe ex UK sector since its launch in March 2001 with returns of 152.73 per cent, beating its benchmark – the FTSE World Europe ex UK index – by more than 50 percentage points in the process.
However, as the graph shows, it has been very volatile over that time and has had the second worst maximum drawdown, which measures how much an investor would have lost if they bought and sold at the worst possible time, in the sector since its launch.
Performance of fund vs sector and index since Mar 2001
Source: FE Analytics
However, it has performed very well over the periods that Brookes has held it in the past.
Between 2001 and mid-2007, the fund more than tripled the gain of the index with returns of 163 per cent. It then subsequently fell 40 per cent between mid-2007 and late 2011 while its benchmark lost 19 per cent.
It was again a top quartile performer between October 2011 and earlier 2014 but is currently languishing in the bottom quartile and underperforming against its benchmark year to date with returns of 0.34 per cent.
Wolstencroft, whose fund has a yield of 3.3 per cent, has more than a quarter of his portfolio in financials and has a high weighting to the periphery, with the likes of Italy making up 6 per cent of his AUM.
Artemis European Growth has an ongoing charges figure of 0.88 per cent.
