In order to stimulate economic growth and stave off the threat of deflation, the ECB recently announced that it would enforce negative interest rates – cutting deposit rates from 0 to -0.1 per cent – and give cheap long-term loans to banks.
The long-term impact of these policies remains unknown, but the large majority of industry experts expect European equity markets to receive a boost from the added stimulus in a similar fashion to the way US equities did when the Fed first implemented its quantitative easing programme.
Abi Oladimeji, head of investment strategy at Thomas Miller Investments, is bullish on European equities and says investors should look to take an overweight position in the region as he expects it to be the leading developed market over the coming year.
“It’s a good move for European equities as the added liquidity should be beneficial. A lot of the outperformance we have seen this year has been driven by the expectation that the ECB would embark on what they have now done,” Oladimeji (pictured) said. “I think we can expect that trend to continue and we would also expect eurozone equities to outperform other developed market equities such as the US and the UK.”
Oladimeji says that the majority of funds with a decent exposure to the eurozone should benefit from the announcement.
Two of the most popular IMA Europe ex UK funds among investors are FE Alpha Manager Alexander Darwall’s £2.4bn Jupiter European fund and FE Alpha Manager David Dudding’s £2.3bn Threadneedle European Select fund, as both have historically offered more “core” exposure to the European market.
According to FE Analytics, both funds have delivered top-quartile returns and have beaten their FTSE World Europe ex UK benchmark over three-, five- and 10-year periods.
Performance of funds versus sector and index over 10yrs
Source: FE Analytics
If investors don’t want direct exposure to the European market, our data shows that there are a number of global funds that have a clear bias towards the region.
The average fund in the IMA Global sector has a 15 per cent weighting to Europe ex UK. However, the likes of Invesco Perpetual Global Opportunities, Morgan Stanley Global Brands and McInroy & Wood Smaller Companies all have close to 30 per cent of their assets invested in European stocks.
Legg Mason Global Equity Income, Schroder Global Equity Income, Veritas Global Equity Income and Newton Global Higher Income are among the IMA Global Equity Income funds that have the highest weighting to Europe.
Source: FE Analytics
Oladimeji says that if investors want to drill down a little further, there are certain regions and sectors within the wider European equity market that will benefit more from the announcement than others.
“I would split it into two parts," he said. "The first would be geographical, as I would expect peripheral Europe to outperform the core because the added liquidity should have a greater impact on the likes of Italian, Spanish and Portuguese equities.”
Funds with a bias towards peripheral and southern Europe have been among the best performers in the sector recently.
One example is James Sym’s Schroder European Alpha Income fund, which currently has a 9.4 per cent position in Spain and 8.8 per cent weighting to Italy. It is the best performer in the sector over the past 12 months, with returns of 34.72 per cent.
Invesco Perpetual European Equity Income has 13.65 per cent exposure to Spain and decent positions in both Italy and Portugal.
FE Alpha Manager Barry Norris’s FP Argonaut European Alpha fund, on the other hand, is considerably overweight Greek equities, with more than 5 per cent of his portfolio invested there. Both the Invesco Perpetual and Argonaut funds also boast top-decile returns over 12 months.
Performance of funds vs sector over 1yr
Source: FE Analytics
Although a little less clear-cut than geographical divergence, Oladimeji says that funds with a clear cyclical bias should outperform those with a high weighting to defensive companies on the back of the announcement.
Ben Gutteridge, head of fund research at Brewin Dophin, agrees and recommends FE Alpha Manager Rob Burnett’s Neptune European Opportunities fund because it is “very well aligned” to play the theme due to the manager’s high exposure to the financial sector.
Unlike Oladimeji, Ed Smith, global strategist at Canaccord Genuity, doesn’t think the ECB’s announcement regarding negative interest rates and cheap long-term loans to banks will have much of an impact.
However, he is excited about the TLTRO [targeted long-term refinancing operation].
“This would be quite a radical step,” Smith explained.
“It would limit the amount banks are allowed to borrow to the amount they are willing to lend to the non-financial sector. This would directly link stimulus to businesses and consumers, which could cause the economic cycle to turn more inflationary, something the US, UK and Japan have all been unable to do.”
Smith says investors shouldn’t make any changes to their portfolio yet. However, he says that when the TLTRO is enforced – which is likely to be next year – investors should keep a close eye on smaller and medium-sized European companies.
“It should benefit some of the non-core areas, but only where there is genuine demand for funds,” Smith said.
“Certain areas, such as SMEs – which may have struggled to get financed – would be an area that could benefit, so when there is some evidence of the TLTRO coming through, I would expect small and mid caps to perform well.”
One of FE’s best rated IMA European Smaller Companies funds is Threadneedle European Smaller Companies, which is headed up by FE Alpha Manager Mark Heslop. According to FE Analytics, it is the sector’s best performer over 10 years, with returns of 361.71 per cent.