Careful investors can reap benefits of European ventures

UK investors often shun Europe, but doing so ignores its benefits, says John Greenwood

(ODD ANDERSEN/AFP/GETTY)

Often perceived as an amalgam of plodding economies held back by inflexible workforces, continental Europe has not been a favourite region for UK investors for some time.

However, the economies across the Channel have held up to the choppy investment waters of the past 12 months far better than the UK. While the UK All Share sector is down a painful 10 per cent over the last year, the Investment Management Association's Europe ex-UK index shows a fall of just 2 per cent.

European companies performed better than those in the UK in the recent bull run too. Over five years, the Europe ex-UK sector has returned on average 129 per cent, compared with the 92 per cent rise achieved by its UK counterpart, yet British investors have to date remained unconvinced.

Negativity on Europe remains in some quarters, but there are financial experts who say the view of continental European equities as an investment backwater is outdated. They point out that with the area making up about a third of the world's economy, it should form an essential part of any investor's portfolio.

"We think there is a stigma against Europe as a dull place to invest among British investors, which is unfounded," says Meera Patel, senior investment strategist at Hargreaves Lansdown. "Balance sheets in continental Europe are at their strongest levels for 20 years and the economy has been more resilient to the recent market shocks than the UK. Over the past year the very worst European equity fund is down just 12 per cent, compared to 27 per cent for the worst UK fund."

As with any overseas investment, UK investors place themselves open to currency risk when they choose Europe. Nobody knows which way currencies will go, but the euro is now at its highest ever level relative to sterling and many experts see that trend continuing, a factor which would benefit UK investors putting money into Europe. Funds investing in Europe also have access to non-euro economies such as Switzerland and parts of Scandinavia.

"European equities provide some currency diversification for UK investors. Recently, the pound fell to new 12-year low compared to the Swiss franc and its lowest against the euro since its 1999 introduction. Owning investments in different currencies can help balance your portfolio's long-term return," says Kate Warne, market strategist at Edward Jones, the financial adviser and stockbroker. "What's more, many expect the UK economy to slow by more than the European economy in 2008, which is part of the reason for the lower pound."

Advisers typically advise an allocation of 15 to 20 per cent of an equity portfolio to companies or funds based in continental Europe.

The current jittery state of the market means many financial advisers are cautious about recommending equity investment anywhere in the world, and the general view is that Europe is not immune to the aftershocks of the US sub-prime malaise or the wider issue of market volatility. Last week, Siemens, the German engineering giant lost 17 per cent of its share value in a day when it produced poor earnings outlook figures.

Julian Chillingworth, the chief investment officer of Rathbones Unit Trust Management, says we can expect more bad news from blue-chip stocks in continental Europe over the next few months, and advises anyone looking at the sector to steer clear of financials and capital goods, such as factories and machinery.

"Our view of continental Europe is that we are going to have a few more surprises like Siemens in the capital goods and financials sectors in the coming months," says Chillingworth. "Now is a time to be cautious in Europe, but there are opportunities out there, and don't forget that companies in the sector are paying higher dividends than in the UK and US. We like utilities companies such as Telefonica, the Spanish telecoms operator that owns O2, and also see value in Nokia."

The message from advisers is if you want to go into the equity market at this volatile time, drip feed your money in over six months, as this will reduce your exposure to violent swings in share prices. Most fund managers will take your money now, so you can maximise your ISA allowance, and invest it in cash, putting tranches of your cash into equities over the following six months.

Advisers say a safer way to invest in uncertain times is through equity income funds. European countries tend to pay higher dividends than their UK and US counterparts, and there are three times as many companies yielding more than 3.5 per cent this year in Europe than in the domestic market. The Resolution Argonaut European Income fund, managed by Oliver Russ, is popular with financial experts. Its top holdings are currently all utilities, including Italian electricity suppliers Terna and Enel and Finland's Fortum.

"We like the Resolution Argonaut European Income fund because you are getting a yield of 4 per cent on the fund and there is also the potential for capital growth," says Patel.

Robert Burdett, the head of multimanager funds at Thames River, is less enthusiastic about the outlook for Europe, when compared with the US, UK and Asia, but says there are good funds out there if you know where to look. He favours the Odey Continental European fund, run by Feras Al-Chalabi. That fund has risen in value by 139 per cent over the past five years, and in today's markets Burdett values Al-Chalabi's attention to downside protection. "As well as achieving high returns, the fund can be cautious if it wants and is now 33 per cent invested in cash. It also did well when markets were falling in 2002, when it only lost 1 per cent," says Burdett. He also rates the Cazenove European Equity fund, run by Chris Rice, and Neptune European Opportunities, run by Robert Burnett.

Europe has such a vast pool of thriving companies to choose from and anyone looking to invest in equities could be doing themselves a disservice by turning their back on the sector. With so much volatility in world markets, investment opportunities on the Continent will perhaps not look quite so dull.

Eastern promise

The collapse of the Soviet bloc saw capitalism drive into the former communist countries of eastern Europe at high speed. The former Russian satellite countries of Poland, Hungary and the now-divided Czechoslovakia, as well as the Baltic states, Romania and Bulgaria, were an emerging market success story years before China and India started grabbing the headlines.

Probably the most celebrated fund in the sector is Jupiter Emerging European Opportunities, managed by Elena Shaftan and Ingrid Kukuljan. Anyone investing in this fund five years ago would have seen their money grow by a whopping 360 per cent, and Shaftan and Kukuljan's knowledge of the economies in the sector mean the fund is still many advisers' favourite for anyone wanting exposure to Eastern Europe. But, as with other emerging market funds, these are not for the faint-hearted – the fund has fallen in value by almost a fifth since the beginning of the year.

It has 66 per cent of its assets invested in Russia, so, depending on your view of where Europe stops and Asia starts – historically the Urals have marked the divide – it is not a thoroughbred European fund. But that crossover between Europe and the emerging markets reflects eastern Europe's perception among investment professionals as a halfway house between the big emerging markets and more developed economies.

"Because eastern Europe is not as far from convergence with the economies of western Europe as China and India, I see it as a short-term play rather than a decades long one," says Philippa Gee, investments director at Torquil Clark. "But there is still value to be had out of the region."