A more stable political outlook, solid economic growth and improving corporate earnings are all contributing to a much more favourable environment for European equity investors, according to Liontrust Asset Management’s Oliver Russ.
Russ, who manages the £186.5m Liontrust European Income and the £58.4m Liontrust European Enhanced Income funds, said fears over the political climate, following an apparent rise in populism across the continent, failed to emerge.
He said: “The prospect of political turmoil was understandably causing significant investor nervousness, although in our view the most feared outcomes never stood much of a chance of materialising in reality.
“This nervousness was most probably leading investors to apply a risk discount to their assessment of European shares’ fair value.”
The manager said while the discount had narrowed during 2017 investor sentiment has improved noticeably since the election of Emanuel Macron as French president in May.
Macron’s defeat of Marine Le Pen signalled greater stability for Europe and security for the EU, as one of its principle members elected a passionate supporter of the bloc.
As such, investor confidence has started to return to the European equity space, with greater inflows into the IA Europe ex UK sector, according to Russ.
And investors who have taken a chance on European equity markets have been rewarded, as the below chart shows.
Performance of indices YTD
Source: FE Analytics
European equity market has performed strongly in 2017, with the MSCI Europe rising by 11.8 1 per cent (in sterling terms), compared with an 8.43 per cent rise in the FTSE All Share index.
However, while flows into active strategies have been on the rise, passive money has been slow to follow. Russ noted that over the past 20 months, there has been “essentially no net flows into European ETFs”, according to data from UBS.
Below, Russ highlights three reasons why the European investment case remains compelling.
A more stable political outlook
Much of the political threats facing Europe in 2017 have been shrugged off. As well as the French election, the German general election passed without too large gains for populist, far right party Alternative For Germany.
While Catalonia’s bid for independence was a significant political event of recent months, said Russ, it was unlikely to trigger the break-up of the eurozone or have any real impact outside of Spain
“This is much less alarming than the horrors posited at the start of the year,” he explained.
“Indeed, if anywhere has taken on the mantle of European political instability at the moment, we would probably have to point to the UK.”
A booming economy
Improving macro fundamentals have underlined strong economic growth for Europe in recent months.
Russ said GDP forecasts have been consistently upgraded throughout the year, with the euro area set to grow by 2.1 per cent in 2017, according to the International Monetary Fund.
“Even now European GDP expectations are probably lagging reality in our view,” said Russ. “We think 2017 GDP growth could eventually turn in at about 2.5 per cent after revisions while in 2018, barring unexpected events, we could see another 2 per cent-plus year.”
A benign environment for corporate earnings
The Liontrust European Income fund manager said that political stability and accelerating economic growth have started to filter down to the corporate level.
“Take the recent Q3 earnings season as a case in point: Barclays’ analysis suggests that with 77 per cent of its European universe having reported Q3 results, the median company beat analysts’ consensus earnings per share estimates by 140 basis points,” he said.
“Admittedly, some of this differential can be accounted for by expectations being set at achievable levels, but it does suggest that the very positive macro backdrop is feeding through to a benign corporate environment.”
Russ said European corporates’ earnings had lagged their counterparts in the US for many years, with the outlook only improving more recently.
He explained: “Even now, nearly 10 years on from the global financial crisis, European earnings – and markets – have yet to exceed prior peaks.
“This is because Europe managed to tack on a second major crisis – the eurozone crisis – almost immediately after the global financial crisis.”
Russ said while his income funds focus more on company dividends than earnings, over the long term greater profits should be distributed more widely to shareholders and could lead to higher dividends.
Taken as a whole, the outlook for European equity markets looks strong with Russ noting that the “European stars… appear to be in somewhat of a rare alignment currently”.
“Potentially, this means not only that earnings numbers can expand, but the multiple paid for those earnings could expand too,” he said.
“Be that as it may, as we now look forward to 2018, we see another solid year of earnings growth – consensus currently stands at circa 9.2 per cent.”
Russ has managed the Liontrust European Income fund since launch in December 2005. He was joined on the fund in June 2017 by Oisin O’Leary.
The fund targets a high level of income in excess of the annual net yield of the MSCI Europe ex UK index. It has an indicative yield of 3.97 per cent, compared with a benchmark yield of 2.99 per cent.
With a concentrated portfolio of 51 holdings, the largest sector weighting is financials representing 32.1 per cent of the fund (as at 30 September). Other significant exposures include industrials (13.9 per cent) and consumer discretionary stocks (8.9 per cent), although these are underweight positions.
The largest holding in the portfolio is French construction group Vinci, representing 3.9 per cent of the fund.
Over three years, the fund has returned 44.72 per cent, underperforming the IA Europe Excluding UK sector average return of 50.16 per cent.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
The fund has an ongoing charge figure (OCF) of 0.88 per cent.