Believe it or not, Europe could be a winner for investors

Negative headlines shouldn't mean investors have to shun the eurozone.

Europe hasn't been popular with investors for some time. The reasons are obvious. The eurozone was in a precarious state long before the first European Central Bank bailout two years ago. Since then it has lurched from one crisis to the next, with Spain and Italy now creating the most financial concerns.

The anniversary of the first bailout falls next Wednesday. So what has happened in the last two years, and is it time to reconsider euro investments?

UK investors shunned Europe long before the sovereign debt crisis began. According to the Investment Management Association, funds in the Europe ex-UK sector attracted the lowest investment of all sectors in 2003, 2004, 2005, 2008 and 2009.

It was bottom once again last year, with investors showing no appetite for Europe. The execution-only broker Chelsea Financial Services reports that less than 1 per cent of its clients chose European equities last ISA season.

But have we been missing a trick? Short-term performance figures from Fundexpert.co.uk suggest that by avoiding the region, we may have missed out on a decent rally. The figures – right – reveal there has been an upturn in the last six months, with high-yield bond funds offering the greatest gains. The average fund in the sector has climbed 7.27 per cent since November.

If you'd stayed invested since the bailout, you'd have made just 8.9 per cent in high-yield euro bond funds.

You would have done better in the European Smaller Companies sector, which posted average growth of 9.16 per cent over two years. But it would have been wiser to stick with bonds in the last six months with smaller firms growing an average of just 5.97 per cent.

Mind you, that's a lot better than the European sector which lost money over the last two years, with the average fund falling 3.46 per cent.

However, to put that into context, over the same time period the Spanish market has slumped 30 per cent, while Greek investments are down a disastrous 60 per cent, according to Brian Dennehy, of Fundexpert.co.uk. "So fund managers have done a good job of avoiding the worst," he pointed out.

He said the cheap money available as a result of the subsequent bailouts – the European Central Bank's long-term refinancing option – had spurred a recovery in euro stock markets and corporate bonds. But he warned that there could be more trouble ahead. "Unless you believe that the euro banking zone is now robust, and all sovereign debt problems are manageable, there are very clear risks from the 'deadly embrace' of eurozone banks and sovereign debt, particularly in peripheral Europe," Mr Dennehy said. "And the political risks are growing by the week – the eurozone is fracturing before our eyes, but few want to acknowledge this."

Others agree that euro finances continue to look fragile. Darius McDermott, of Chelsea Financial Services, said: "We're not out of the woods yet. There is a lot of potential political change coming up with elections in a number of countries."

The presidential elections in France have gained the most publicity in the UK so far, with intense focus on the face-off vote between President Nicolas Sarkozy and François Hollande tomorrow.

Bill Stormont, manager of the Henderson Horizon Pan European Equity fund, said: "It will be interesting to see whether Hollande, if elected, will be able to influence France's partners in Europe – primarily Germany – to transition away from a purely 'austerity über alles' European agenda to one more concerned with growth."

There are also upcoming elections in Germany, Holland, Russia and Spain and – tomorrow – voting on the Greek parliament.

"Election outcomes will be crucial to the future of the eurozone, especially because of the leading role and close relationship incumbent Sarkozy has enjoyed with German Chancellor Angela Merkel," said Azad Zangana, a European economist at Schroders.

"Election results could eventually lead to a collapse in the deal between Greece and the Troika, which will force Greece to leave the euro by 2013."

Mr Zangana said the targets set out for Greece in the latest bailout package were likely to be missed while the economy remained in deep recession. "When faced with the prospect of yet more austerity the Greek government are likely to decide to leave the euro," he said.

Trevor Greetham, Fidelity's asset allocation director, agreed. "The euro area is suffering from the toxic combination of a competitiveness crisis and a debt crisis as the same time. Austerity aimed at deflating peripheral wages to restore competitiveness with Germany reduces the ability of consumers and governments to service their debt and worsens the crisis."

Mr Greetham's view is that there needs to be a deepening of the financial support from strong to weak countries. "But the fact remains that either the euro area breaks up or it evolves into the United States of Europe," he said.

Despite the negative sentiments, Mr McDermott says there might still be opportunities in Europe. "The market is cheap on all historical measures, and even with all the volatility and bad economic news, investors who stayed with the sector have seen positive returns.

"European companies are actually in much better shape than their governments. For the contrarian investor, it might well be worth thinking about Europe for a small part of their portfolio, but they will need to look past the bad news and market reactions and really think long term."

He picks Jupiter European Special Situations and Blackrock Continental European for equity investors. "When it comes to bond funds, I favour corporates over government and even high yield, which has greater default risks."

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