Rich pickings for investors happy to channel-hop

The Continent is the place to go for investors in the know, says David Prosser

The conspiracy of silence over Europe that was so obvious during the election campaign may have suited all the major political parties, but investors ignore the region at their peril. Not only are economic indicators improving in the single currency zone, but Europe now includes a number of emerging markets.

The conspiracy of silence over Europe that was so obvious during the election campaign may have suited all the major political parties, but investors ignore the region at their peril. Not only are economic indicators improving in the single currency zone, but Europe now includes a number of emerging markets.

Stock-market returns on the continent have improved markedly over the past two years. The average fund investing in European equities (excluding the UK) was up by 19 per cent over the 12 months to 1 April. Over two years, the figure was 59 per cent. In both periods, shares in large European companies outperformed all their rivals in the developed world.

It has been a similar story in countries that joined the European Union 12 months ago, including Poland, Hungary and the Czech Republic. Over two years, funds that invest in these countries are now almost 100 per cent up.

In developed Europe, the economic picture remains benign, according to analysts at Commerzbank. They say that risks such as rising oil prices and an appreciation in the value of the euro have so far been mitigated this year by stronger than expected economic performance.

Tim McCarron, the manager of Fidelity European, says that another important trend for investors has continued to develop in recent months. Fidelity's research shows that dividend yields on European shares are up nearly 60 per cent compared with five years ago.

The trend could be useful for investors seeking both income and growth. "Over the long term, dividend yields make up a substantial portion of returns," says McCarron. "Investors should look at total returns rather than just capital appreciation."

Max Anderl, manager of UBS's European Equity fund, is also excited by the prospects. "As cash on the balance sheets is diluting returns, European companies are choosing to return cash through buybacks and higher dividends," he says.

Alan Steel, who runs the independent financial adviser Alan Steel Asset Management, says that continental Europe is an obvious starting-point for UK investors who need to diversify. He points out that under the old personal equity plan regime, replaced by individual savings accounts in 1999, investors were very limited in the sums they could put into funds with international holdings. As a result, many investors have portfolios that are over-exposed to the fortunes of the UK stock market. Switching some money into Europe is a good way to address that problem, Steel suggests.

Andrew Merricks, head of investments at IFA Skerritt Consultants, is also a Europhile. "Just before Christmas, I asked a panel of fund managers which of their own funds they would back if they were buying a present for their parents," he says. "None of them had previously talked up the prospects for Europe, but all said it was the market they would back in 2005.

"The chief risk is currency movement - if you make sterling investments in shares denominated in another currency, there is always a chance of losing out," he says. "But right now, the euro doesn't worry me and if there is any repeat of recent wobbles in its strength, that can only help UK investors."

In many respects, the outlook in Europe is very similar to that in the UK. Inflation has been edging up, and stock-market performance has been patchy. The best shares have made significant gains, but markets as a whole have been trading in a narrow range.

On the other hand, consumer spending remains strong, with the baby boomer generation driving demand. And there is no reason to think inflation is running out of control.

Germany, moreover, is well-placed to benefit from its strong trading ties with China, which is expected to power the global economy over the next 10 years. And in France, all eyes are on the referendum on the EU constitution, scheduled for 29 May. A yes vote could provide a market fillip.

Meanwhile, in emerging Europe, the question is how quickly the EU accession states will catch up with their developed counterparts - investors stand to be benefit as these countries' markets are re-rated.

Craig Wetton, of IFA Chartwell, says many investors currently regard Eastern and central Europe as being in the same category as high-risk emerging markets such as Latin America. "You can certainly argue that there is a greater degree of risk, but I think it is much lower than in traditional emerging markets," he says.

That's also the view of Alain Bourrier, co-manager of Merrill Lynch's Emerging Europe Fund. "The convergence process has provided a unique opportunity for wealth creation," he claims, "both for recent entrants such as Poland, the Czech Republic and Hungary, and also for countries such as Turkey." Productivity in the countries that have recently joined the EU is growing at 10 per cent a year, says Merrill Lynch.