European funds are the most popular regional equity portfolios among investors for 2016, according to a recent FE Trustnet poll, while global emerging markets and Asia Pacific ex Japan remain the least favoured areas of the stock market.
The poll, in which 2,524 FE Trustnet readers voted, showed that 29 per cent believe Europe to be the best hunting ground over the coming 12 months. The UK and Japan were in second and third place as 23 per cent and 15 per cent, respectively, deemed those regions to be most attractive in 2016.
Despite the continual underperformance of emerging markets relative to developed world equities over the last five years or so as well as the low valuations on offer, few investors seem prepared to bite the bullet as global emerging market and Asia Pacific ex Japan funds were the least popular, according to the poll.
In truth, it comes with little surprise that so many are bullish on European equities given the large majority of multi-asset and global managers are overweight the region within their portfolios.
In that respect, little has changed from a year ago as Europe was touted as being the most attractive market for 2015 given its relatively low valuation compared to the US, signs of economic improvement in the troubled eurozone and the prospect of full sovereign QE from the ECB.
Despite the Greek debt negotiations and the region dipping into deflation on the odd occasion, FE data shows that investors were largely rewarded for backing European funds last year.
Performance of sectors versus index in 2015
Source: FE Analytics
In what turned out to be a highly volatile 12 months, the average fund in the IA Europe ex UK and IA European Smaller Companies sectors returned 9.29 per cent and 19.22 per cent, respectively, in 2015 compared to a 3.29 per cent gain from the MSCI AC World index. 
Ben Willis, head of research at Whitechurch, says investors are right to be bullish on Europe once again in 2016.
“We would agree with the overweight to Europe. The economic recovery in Europe is gathering momentum underpinned by ECB’s QE measures,” Willis (pictured) said.
“We are beginning to see strong growth, particularly in some of the peripheral economies (e.g. Ireland and Spain) that suffered the worst in the downturn. The ECB has already intimated that if the recovery starts fading they will increase stimulus measures.”
“Given this, we believe stock market valuations look attractive with scope for profit upgrades across many sectors and with several European government bond yields below 1 per cent, the yield on equities looks enticing too.”
As European stocks have largely underperformed other developed markets such as the US and UK since the global financial crisis (thanks largely to the European sovereign debt crisis of 2011), Premier’s Simon Evan-Cook says that the region is one of his favourites at this stage in the cycle.
“Within the context of generally being cautious across most equity markets, yes we’re more bullish on European equities than we are on some other markets. They look better value, while they may well be earlier in the cycle than the US, where equity valuations look stretched and there is very limited potential for further earnings growth,” Evan-Cook said.
Performance of indices since the global financial crisis
Source: FE Analytics
Ben Conway, fund manager at Hawksmoor, strikes a more cautious tone, though.
While he agrees that Europe is a fundamentally attractive region for the year ahead, he says the reason for that is the economy. Therefore, given the lack of funds which purely focus on domestic Europe (compared to those which own multinational European stocks), he urges investors to tread carefully.
“We are certainly moderately confident on the European economy, but, as you know, the stock market in Europe is not very representative of the economy (in fact, stock markets are usually very poor representatives of the economies they are associated with),” Conway said.
“The best way to play an ongoing QE-supported recovery in the domestic European economy is via smaller company shares or private equity invested in businesses that are wholly focused on their local area. There are not many European equity funds that can offer this exposure.”
There are also those who think investors are wrong to follow the crowd and back European equities this year.
These include Rathbone’s David Coombs, who warned FE Trustnet that a worsening political landscape, in the form of the rising popularity of anti-immigration parties, meant the continent is a far too dangerous place to invest at the moment.
“We believe things will only get worse for the eurozone due to its political paralysis and yet to be resolved structural issues,” Coombs said.
Nevertheless, in an article later this morning, we will take a look at the funds best suited for investors who are bullish on European equities.
Turning to the other end of the spectrum and, yet again, it isn’t too unexpected that emerging markets remain out of favour with investors.
It seemed the developing world was the catalyst the large majority of last year’s volatility, with China’s slowing growth enough to spark one of market’s worst trading days since the global financial crisis in August – a session which has since been dubbed ‘Black Monday’.
On top of that, falling commodity prices, the impact higher interest rates in the US will have on certain economies and political issues have all dogged the asset class.
Nevertheless, it is worth bearing in mind that the MSCI Emerging Markets index has now lost 20 per cent over five years (meaning it is some 70 percentage points behind developed market equities over that time) and has underperformed the MSCI World index in each of the last three calendar years.
It is also down 3 per cent already this year thanks to Monday’s China-led sell-off.
Performance of indices over 5yrs
Source: FE Analytics
However, given that huge difference in returns, the low valuations on offer and the fact that so many people are already bearish on emerging markets, are FE Trustnet readers right to ignore them within their portfolios this year?
“We can see relative and absolute value in emerging markets but investing in these areas are for only those who can stomach the risk. Chinese growth concerns and low commodity prices have dominated these markets (and developed markets too) and we do not see this scenario improving anytime soon as we move into 2016,” Willis said.
“However, there is a healthy amount of pessimism now priced into these markets and so could provide a good entry point for the long-term investor (i.e. with a 10-year view).”
Neil Shillito, director of SG Wealth Management, agrees that now is the time to be looking to buy emerging market funds rather than avoid them.
“Ever the contrarian, we are going to increase our weighting to emerging markets on a 12 month view. We shall probably get caned in the short term but are convinced that good returns are to be had,” Shillito said.
Conway, however, says investors need to be very selective with emerging markets. He is considerably underweight emerging markets as a whole within his portfolios, but given the differing growth trajectories within developing economies, he is backing specialist regional mandates instead of a catch-all fund.
The majority of those focus on Asia ex Japan – an area he really thinks investors should be looking to up their exposure at this point in time.
“Asian economies are generally in better shape than those in Latin America. More importantly, Asia happens to be home to some truly exciting companies capitalising on growth thematics that do not depend on the vagaries of the performance of the global macroeconomy.”
Evan-Cook agrees with Conway, noting that the major bull cases for investing in Asia of the mid-2000s have not disappeared.
“Valuations here are more appealing than in developed markets, while all the arguments about younger, growing populations (albeit with some notable exceptions such as China) haven’t gone away overnight,” he added.
