Investors are trimming their underweight positions to Europe due to improving macroeconomic data, the easing of political tensions and relatively cheap valuations, according to Michael Clements, manager of the top performing Oyster Continental European Selection fund.
The FE Alpha Manager said there are a number of factors that mean sentiment towards this year’s top performing region is steadily improving.
“A lot of my clients are still underweight Europe in their allocations but are either moving or thinking about moving back to neutral,” he said.
One reason they have started to move back into Europe is the fact that some remain nervous about valuations in other areas such as the US or in fixed income, which have been on a particularly strong rally in recent years.
In comparison, over five years Europe has lagged other major markets, with the MSCI Europe ex UK returning 113.04 per cent compared to the S&P 500’s 137.13 per cent gain.
Performance of indices over 5yrs
Source: FE Analytics
“Most clients don’t want to be in the US or the bond market but Europe generally seems the least bad choice,” he said. “A lot of clients see Europe as a safe place to go in this very tricky asset allocation environment.”
“People are doing the usual thing of rotating out of something that has worked into something that could work in the future and that is the US to Europe trade.”
He said this has occurred more recently thanks to a combination of factors, but improving macroeconomic data has been of particular comfort to investors in the low growth environment.
“If you step back, the macro side is as good as its going to get for a while,” Clements said.
“I’m not a macro investor and I do not spend a lot of time looking at macroeconomic data points but [when I do] they are all going in the right direction broadly speaking. 
“Interest rates are still low, oil prices are coming down generally which gives a tailwind to an oil importer like Europe, GDP is generally going up – some faster than other.
“Look at the UK economy, the French, German – all the signs are that these economies are getting stronger not weaker.
“Unemployment indicators are coming down, industrial production looks fine and I think this is an important point if you are an investor into the European market because ignoring politics – which you can’t ignore entirely – but if you step away and look at the market and the economies which are driving these companies that we are investing in they are actually okay.”
While he admitted they are “not brilliant”, the manager said they are much better than they were four or five years ago.
“So I think the politics notwithstanding the economic backdrop is fine and probably a tailwind not a headwind,” Clements (pictured) said.“Hence I can see why more investors are starting to switch out of the bond market and the US equity market into Europe because although we can debate whether the valuations are high or not but they are definitely lower than elsewhere and the economic situation looks okay.”
Indeed, turning to valuations, Clements said that looking at the European market on a standalone basis it is “probably somewhere between fair value to slightly expensive”.
He added that like other markets there are parts that look very expensive and parts that look reasonably cheap.
“But with the market up 14.11 per cent this year it is getting higher because the economic situation hasn’t really changed but prices are going up so the markets are becoming more expensive,” he warned.
Looking at stock specifics, earnings growth in Europe is expected to increase by some 10 to 15 per cent over the course of this year, which, while seemingly high, he said is perfectly possible.
“From a non-macro investor that doesn’t spend a lot of time looking at it I look at that data and think it is optimistic but it is possible because what you’ve seen over the last three or four years is a lot of cost cutting in the face of a lacklustre economy,” he said.
“And what’s happened now is that GDP is improving which means revenues are generally driven higher and when you’ve got higher revenues against a cut cost base you get this operational leverage.
“Say you get 5 per cent revenue growth against a flat cost base then it is possible to get to this earnings growth estimate – especially with the banks recovering after years in the doldrums.
“Whether we end up there I don’t know but for the first time in many years I can see that we actually have a chance of meeting these expectations.”
Turning finally to politics, Clements said both the French and British elections had passed by without much volatility – something he looks for around these events –calming the market.
“What we don’t do is we don’t respond to it in the sense that we don’t take a view on which way the election will go and place our bets,” he explained.
“We just let it play out, make sure we don’t lose money over the period and then just take advantage of volatility.
“But we haven’t don’t very much recently because the French elections came and went and the market barely moved and the British election came and went but the stock market didn’t move
“If you are waiting for dislocations in share prices there is nothing to do because nothing has changed from one day to the other.”
He noted that there may be some volatility in the coming months around a potential Italian election, but added that this is unlikely to create too much panic in the wider market.
However, overall Clements said he manages the fund with a pure bottom-up stock picker mentality, meaning that he focuses more on companies than economics.
His £95m Oyster Continental European Selection fund has been a top quartile performer over the last one and three year periods.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Since its launch in 2013, the fund has returned 60.64 per cent, beating the IA Europe ex UK sector and MSCI Europe ex UK index by 10.08 and 13.16 percentage points respectively.
In its latest factsheet, Square Mile Research said: “This highly attractive offering is aimed at investors who are looking for a concentrated European ex UK vehicle to sit alongside their core holdings.
“There is a strong quality mantra underpinning the strategy but pleasingly this is coupled with a strong focus on buying these companies cheaply.”
The concentrated portfolio of around 30 stocks aims to buy quality companies that have been mispriced by the market and has a much lower portfolio turnover than its peers.
The four-crown rated fund has a clean ongoing charges figure (OCF) of 1.29 per cent.