The euro - trick or treat?

Not for the first time, Europe caused the UK government problems last month. But as Gordon Brown toughed out another storm over economic and monetary union, investors must wonder why the very mention of the E-word so terrifies the politicians. After all, anyone who invested in European equities in recent times should have profited handsomely.

Even after the current bout of stock market volatility, which has affected continental markets as much as UK equities, European share prices have made dramatic gains this year. The FT-SE Eurotrack 100, the index tracking a wide basket of European shares, is up around 30 per cent in sterling terms since the beginning of 1997.

Of course, the fact that European markets have done well so far this year, notwithstanding recent problems, does not mean that they will continue to do so.

The major issue for Europe over the next few years is the single currency. And if there is one thing that causes stock market problems, it is uncertainty. However, many analysts and fund managers remain positive about the outlook for European equities over the short to medium term. Talal Shakerchi, manager of Old Mutual's successful European Unit Trust, says: "I'm much more optimistic today than I usually am."

While the single currency debate will continue, many analysts now feel sufficiently confident to predict that the issue may not be calamitous for stock markets. "EMU implies more interest rate convergence and stronger growth," says HSBC James Capel, while ABN Amro Hoare Govett notes: "The only way to guarantee EMU's success is to engineer as much economic growth as possible."

Moreover, there are plenty of other factors that should encourage share price growth. Mr Shakerchi says: "There's a wave of restructuring going on in Europe. Lots of companies are now being run more efficiently and they are really starting to talk about shareholder value."

All the same, risks remain. If EMU goes badly wrong, for example, the impact on share prices is very difficult to predict. Also, share prices are now valued very highly in historical terms, even if markets have dropped back from the summer's peak. UBS warns: "We have difficulty rationalising valuations in some markets ... if we are right, future returns will prove disappointing to many investors."

Most investors would be wise to stick to investing in European equities through an investment or unit trust rather than buying individual shares. There are plenty of funds to choose from.

Investment trusts can offer better value than unit trusts because their share prices often trade at a discount to the value of their investments.

Before investing in a particular unit or investment trust, make sure that you understand what you are buying. Some trusts invest in smaller companies or specialise in the emerging markets of eastern Europe, which involve higher risks and increased price volatility.