Portugal's bond boost offers glimmer of hope for Euro funds

A eurozone collapse looks to have been avoided this week, but investors should continue to tread warily and look north.

Portugal has been much in the news this week as the focus of concerns about the potential collapse of the eurozone. All eyes were on the country's bond sale which, if a failure, could have pushed the economy into needing a bailout. But the five and 10-year bonds were oversubscribed, easing worries about Europe's woes.

For those invested in European funds that should be good news, especially when it was followed by successful bond auctions in Italy and Spain on Thursday. But is it time to think about getting out of Europe ahead of potentially worse news ahead, or should investors be planning to put more of their portfolio into Europe to take advantage of the chance of recovery?

Adrian Lowcock, senior investment adviser at Bestinvest says there is a potential silver lining in this week's news. "Over the last month we have seen the Chinese pledge support to the eurozone and have deep enough pockets to bail out the Portuguese and the Spanish even if the Europeans don't. Perhaps that is why the Portuguese bond issue was more than three times oversubscribed."

"There are also signs that governments in Europe are starting to come to terms with the issues and are looking at longer-term solutions, with Germany backing proposals to increase the lending capacity and powers of the €440bn (£366bn) eurozone rescue fund," says Lowcock.

However the success of the Portuguese bond issue may just be delaying the inevitable, warns fund manager Michael Riddell of M&G Investments. "I wouldn't read too much into a strong auction. Both Greece and Ireland had strong auctions prior to their bailouts, because market markers were short of the bonds going into the auctions and then short-covered (bought back) these shorts during the auction," Riddell explains.

He predicts a resumption of the "slow car crash that is European sovereigns" over the next few weeks. Eventually he warns that Portugal will need a bailout but his view is that it will be manageable. He points slightly further north for the potential root of a eurozone collapse.

"The real problem is Spain, whose economy is twice as big as Greece, Ireland and Portugal combined," Riddell says. "In some ways the Spanish economy resembles Ireland's. The country's government debt level is fairly low, but it's the banking sector you've got to worry about. If Spain gets into trouble, and there's a real risk that it will, then we'll be facing the problem of something that's not just too big to fail, but too big to bail."

Riddell fears that we could end up with a much weaker euro, and a worsening of the eurozone debt crisis. "If some resolution is not reached soon, and I'm not sure there actually is a solution that doesn't involve painful debt restructuring, then the crisis could easily spill over from the bond markets into other financial markets," Riddell says.

He's not the only money manager to look ahead with some trepidation. Tristan Hanson, head of asset allocation at Ashburton Investment Managers, warns that some European countries could still be forced to default on loans. "That Portugal, Spain and Italy were all able to issue long-term debt this week has provided some respite. But while that's good news, Europe's leaders are not yet out of the woods."

Hanson says that an increase in bailout facilities could be announced at next week's Eurogroup and Ecofin meetings or at February's meeting of EU heads of state. "The issue of long-term solvency remains highly pertinent," he warns. "The long-term debt profiles of Greece, Ireland, Portugal and, to a lesser extent, Spain and Italy mean debt restructurings – the polite word for default – are distinct possibilities at some point during the next decade. Any shock, for example another banking crisis or renewed recession, would turn those possibilities into probabilities."

The picture painted by Riddell and Hanson is not pretty. But the downbeat forecast doesn't necessarily mean investors should flee Europe. In fact there are still opportunities in the sector, says James Inglis-Jones, fund manager, Liontrust Asset Management.

"Although Europe as a whole continues to struggle under the weight of excessive private and government debt, European equity markets have continued to make strong progress," Inglis-Jones points out. "Investor sentiment has benefited from a stronger-than-expected recovery in European exports, particularly from Germany and the Nordic countries, and the prospect of further quantitative easing from the US Federal Bank." But he warns that growth will remain very dependent on China and other emerging markets.

Investors looking to Europe should focus on Germany, says Stephen Barber, who advises online stockbroker Selftrade on markets and economics. "Investors have shied away from the eurozone given its high-profile sovereign debt crisis, but on the whole this affects only the peripheral economies of Ireland, Greece and Portugal. By contrast, Germany has returned to fairly solid growth and exports and its finance minister is already talking in terms of full employment," Barber points out. "Nevertheless, for investors interested in Europe as a whole, long-term steady growth is what is needed."

Adrian Lowcock agrees. "Any investors going into Europe should be predominantly buying into Northern Europe, Germany, France and Scandinavia where the companies are doing well," he says. "However investors should only drip-feed their money into the region and buy on weakness. Investing in Europe will be for the longer-term." His fund tip is Blackrock European Dynamics.

EU has its strengths

"Investing in companies in the European Union should provide diversification that an investment portfolio based solely in UK companies may not provide," says Sheridan Admans, investment adviser at The Share Centre. "For example Denmark is a world leader in alternative energy solutions and Germany has world class engineering companies and car manufacturers.

"However markets remain fractious over continued European sovereign debt concerns and the strength of the European banking system. Volatility could persist for some time but this is not necessarily a bad thing. Concerns over debt have led the euro lower and a further upset could apply further pressure to the currency.

"So for the brave, now might be a good time to dip your toe into European investments. Our favourite fund within the sector is the BlackRock European Dynamics fund. It invests across the all-cap market, comprising around 35-65 companies. The fund has outperformed its sector across all time periods."