European equities are attractive despite a sustained period of underperformance, according to Martin Todd, co-manager of the Hermes European Alpha Equity fund. 
While the recent Brexit vote caused concerns and with other political and macro-economic issues are also weakening investor sentiment, Todd remains steadfast in his support for Europe.
The region has struggled since the financial crisis in 2008, and investors and fund managers have remained unwilling to trust the area again, with reasons including the sovereign debt crisis and tightening monetary policy by the European Central Bank at a time when others were easing conditions.
Performance of indices since 2009
Source: FE Analytics
As the graph above shows, the MSCI Europe (ex UK) has been the worst performing index since the financial crisis in 2008, as it has taken the longest to recover.
The index has still returned 77.89 per cent since the start of 2009, but this is less than half the return from the top performing S&P 500 (186.89 per cent).
The biggest concern for investors at the moment is the impending Brexit, with UK’s FTSE 100 underperforming since the EU referendum in June.
Todd said: “I think a lot of people were worries about it (Brexit) but what we have has since is a realisation that nothing’s changed yet.”
Indeed, following a 1.1 per cent drop in the preceding days, the MSCI Europe (ex UK) has picked up, returning 11.77 per cent since – just one percentage point below the rallyin S&P 500.
He says that data, such as the recent European car sales, as well as positive company earnings reports suggest the result in June has had little impact in Europe.
“I think a lot of people were worried about it and what it means for European markets but actually it’s not really a factor at the moment – so if that’s one of the big concerns then I don’t think it’s much to worry about,” he said.
He says the Brexit fear can be likened to the concerns in 2011 around the potential Grexit – when Greece became so indebted that it was likely to leave the EU.
Todd said: “In 2012 we wrote a piece about ‘why [invest in] Europe’ and the biggest concern at the time was Greece. At the time there were very legitimate concerns but if you’d taken your money off the table then you would have missed out on an about 60 per cent return since then for our fund.”
Indeed, since the start of 2012, the fund has returned 69.44 per cent while the wider European market has returned 68.51 per cent, as the graph below shows.
Performance of fund vs index since 2012
Source: FE Analytics
“We’ve been here before, the markets continued to do well and our fund has continued to outperform and I think it could easily happen again,” Todd said.
He says that while investors may be concerned by political and macroeconomic issues, he is not as concerned about the health of the European market.
“European companies are global companies that are exposed to the emerging markets and global growth and they have global brands - so it’s best not to confuse concerns about politics and concerns about economics for the market.”
Despite this, data shows global funds have sold equities for 29 weeks in a row, the longest run since the financial crisis, showing that sentiment remains low.
“People are scared to invest in EU equites and that for us is a positive because there is room for that sentiment to change,” Todd said.
He points to the cheap financing options for companies within Europe as a big competitive advantage compared to rivals in other regions.
“You’ve got really cheap financing now and that’s likely to continue because the ECB wants to do everything it can to help so rates aren’t going anywhere,” he said.
“A couple of European companies (Sanofi and Henkl) have just issued corporate bonds and they’ve been issued at a negative interest rate so they are basically being paid to borrow money. That is clearly a positive for equities.”
These funds can be used to reinvest in the business, or for acquisitions, which is another key draw to the European market.
He also says M&A could pick up in the region, with the likes of ARM Holdings already being taken over, while Deutsche Bourse remains in the process of merging with the London Stock Exchange.
This activity, he says, shows there is still value in Europe.
Todd also believes the companies within Europe have had to be better than many of their rivals since the financial crisis, with little help from outside factors.
While ECB President Mario Draghi is now focused on loose monetary policy to stimulate growth, in the immediate aftermath of the crisis this was not the case, forcing many companies to adapt in order to survive.
Performance of index in the three years following the financial crisis
Source: FE Analytics
In the three years following the financial crisis (2009-2012) Europe was the worst performing index, lagging the next worst S&P 500 by 29.07 percentage points.
“For European companies to survive the last eight years since the financial crisis they’ve come through a period where demand has been very low and it’s been a very difficult operating environment,” Todd said.
“So these companies have had to adapt, take costs out, restructure and innovate just to survive,” he added.
“They’ve come through this tough period without any help from the economy or anything else so having come through that, if you do see a pickup of demand that will feed through to margins.”