European funds sector review – a mixed performance from the bloc

Europe has once again become the epicentre of the coronavirus crisis, bringing fresh economic worries to the region.

In early March, Europe’s average count of coronavirus-related deaths overtook Asia’s, and Italy and Spain fast became the global hotspots. While the focus later shifted to the US, a recent rise of cases in Europe has pushed the daily death toll higher than its April peak.

This rebound in cases has forced lots of European economies into new lockdowns with some countries facing tougher rules over the festive period.

This article isn’t personal advice. If you're not sure if an investment is right for you, please seek advice.

All investments fall as well as rise in value, so you could get back less than you invest.

How have economies reacted?

After a chaotic start to the year, Europe’s restrictions over the second quarter (the three months from March to June) helped to stem cases and allowed countries to reopen. These restrictions were arguably lifted too early, and now the latest round of lockdowns will be a headwind to any potential recovery in the economy.

Predictions on economies across Europe bouncing back have been quickly downgraded. The eurozone economy is now forecast to shrink by 2.3% in the final three months of this year.

However, the impact of new restrictions are expected to be less severe than the measures introduced in the spring. This is partly because businesses are now better placed to deal with the disruption. But the overall impact on economies and businesses is still significant, and has already affected employment levels and financial wellbeing.

The services sector has unsurprisingly been one of the worst hit areas, hospitality, non-essential retail, leisure, tourism and hotels all bearing the brunt of the shutdowns.

In spring, the European Central Bank (ECB) introduced a new round of money printing to stimulate the economy – otherwise known as quantitative easing (QE). In this round of QE, the ECB aimed to buy €1.35tn of bonds to support economies.

With a fresh wave of infections and restrictions, this month the ECB has promised to buy €500bn more bonds. Extra cheap funding will also be provided to banks, as long as they continue to lend to businesses and households.

While this level of support doesn’t need to be used in full if the economy recovers quickly enough, the ECB has confirmed support could be expanded further if needed.

Overall these stimulus measures are aimed at stemming the economic damage caused by the coronavirus pandemic. Governments and businesses are being encouraged not to worry about rising debt levels. Low interest rates and a seemingly infinite QE programme will continue to keep borrowing costs low.

What about Europe’s stock markets?

Like most major global stock markets, the broader European stock market took a tumble in March. It has since recovered somewhat, rising 7.3% over the past year*.

While it’s fared much better than the UK, it hasn’t kept pace with some other global markets, like the US, Japan, and most Asian markets. As always past performance isn’t a guide to future returns.

Looking a little closer, you’ll see there’s a divergence between the performance of different European markets. Much of this has to do with how different economies have coped with the virus.

Denmark, for example, where virus cases have been relatively lower, has grown 37.9% over the past year*. Other northern European markets, like the Netherlands and Sweden have also done well. Spain, one of the worst-hit countries, has fallen 6.1%.

The real outlier though is the eastern European market. Russia, which makes up a large part of this market, has fallen 17.3%. Apart from the virus, the oil & gas sector has been weak, damaged by an oil price slump earlier in the year. This has been painful for Russia as an exporter of natural resources.

Chart showing performance of European markets

Past performance is not a guide to the future. Source: *Lipper IM to 30/11/2020.

Certain sectors have also fared better than others. As already mentioned, oil & gas companies have dealt with the blow of a volatile oil price. Banks and other financial businesses have also struggled due to worries over their ability to cope without enough support from key central banks. That said, we saw a rebound in the sector in November, following news of successful coronavirus vaccines.

Healthcare companies have held up pretty well this year as demand for medicines remains stable, as well as the boost from hopes for a vaccine. So have utilities businesses, which typically do well in times of trouble. Some technology companies have also benefited, as people have looked for new ways to shop, communicate, and be entertained.

What to expect in 2021?

Going forward, market swings and uncertainty is likely to continue, especially as the pandemic is evolving quickly. The rates of infection in Europe might have flattened somewhat over summer, but the recent resurgence means a full recovery has taken a backseat for now.

The speed at which vaccinations can be rolled out across Europe will play a key role in how the continent’s recovery progresses. It’s going to take some time to stabilise economies, not only in Europe, but globally. But eventually this should lead to a more stable return of local demand and customer spending, which should lead to company profits.

Over the longer term we think Europe has stored up potential – it's home to some of the world's most successful companies. And some carry out business worldwide, so they provide exposure to global markets, including faster-growing economies.

All investors should make sure they have a diversified portfolio, whether by fund, geographical area, or type of asset (like shares, bonds, property, gold or cash). By holding investments with different drivers of returns you could reduce the chances of them all performing the same way.

What the Research team have been doing

We’ve had a lots of meetings with European fund managers recently, and analysed a number of upcoming manager changes.

This included a call with David Dudding and Benjamin Moore at Threadneedle. Dudding will step down as co-manager of the Threadneedle European Select Fund on 1 January 2021, but will remain a deputy manager.

At this time, Benjamin Moore will be appointed lead manager. He has been co-manager of the fund since April 2019 and part of Threadneedle's European equities team since 2015. Roberta Zeno, who joined Threadneedle earlier this year, will also become a deputy manager.

While we‘re disappointed to see Dudding take a slight back seat on this fund, we’re encouraged he will remain a deputy manager. Fund performance has been strong this year and you can find out more about this and our views in the latest update. Past performance isn’t a guide to future returns.

Threadneedle European Select fund update

BlackRock European Dynamic will also see a manager change in the New Year. Alister Hibbert will step down as co-manager, while Giles Rothbarth, co-manager of the fund since 2017, will take over as sole manager.

Hibbert has decided to focus his time on a new challenge in the form of a global strategy. We have met Rothbarth lots of times and we think he’s a good fund manager. We’ll continue to monitor the fund under his stead.

We also spoke with Mark Heslop and Mark Nichols, who joined Jupiter from Threadneedle in 2019. They took over management of the Jupiter European Fund last year, and also launched the Jupiter European Smaller Companies Fund earlier this year. We discussed both funds and found out more about the team they’ve formed since joining Jupiter.

Before moving to Jupiter we felt the managers built their own respectable track records. While Nichols focused more on larger companies, Heslop took a lead on smaller businesses. We think this fund could be a good option in the European sector and expect the managers to do well over the long run, although there are no guarantees.

That said, our current choices on the Wealth Shortlist have longer track records and have delivered impressive returns. The team is also relatively new, and we ‘d like to see how they get on over a longer period.

Jupiter European fund update

How have Wealth Shortlist funds performed this year?

European Wealth Shortlist funds have delivered mixed performance over the past year. We usually expect this though, as it's in line with how we select funds for the Shortlist. If all funds in a given sector are performing well at the same time, they're probably investing in similar areas. Those same areas won't perform well all the time, so it can be painful when they're out of favour.

We prefer to take a diversified approach by investing with managers who have a variety of strengths, styles and areas of focus. Remember that past performance isn’t a guide to the future, and performance over one year is a short time period.

Threadneedle European Select has had a strong year, helped by a focus on companies expected to deliver year-on-year growth. It’s grown 16.1%* over the past year compared with 7.3% for the FTSE World Europe ex UK Index.

In particular, Swiss biotechnology firm Lonza and German chemical and ingredients distributor Brenntag have been two of the fund’s top performers. Newer holding Worldline, a French credit card processing and payment services company, has also performed well so far.

It’s been a tougher year for TM Crux European Special Situations. The fund has still made money, but not as much as the broader European market. While fund manager Richard Pease invests in some growth stocks, he also invests in undervalued companies he believes have good prospects, but are yet to be noticed by others.

Some of these businesses have stayed out of favour with lots of investors and performed poorly, putting pressure on the fund's performance.

Pease has an exceptional long-term track record though, and has invested in European companies for more than thirty years. We maintain our longer-term conviction in the fund, but there are no guarantees about future performance.

Barings Europe Select is slightly different as it focuses on higher-risk small and medium-sized companies. It performed mostly in line with the broader market of European smaller companies until the start of November, but lagged the strong market rally last month.

This is broadly what we expect from the fund. Over the longer term it’s tended to hold up better than the broader market when it's fallen, but lag rapid market rises. It held up better amid the market volatility in March, for example.

The Legal & General European Index Fund is also on the Wealth Shortlist. It aims to track the performance of the FTSE World Europe ex UK Index, which it’s done well this year.

Past performance is not a guide to the future Source: *Lipper IM to 30/11/2020.

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More on Threadneedle European Select, including charges

Threadneedle European Select key investor information

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More on TM Crux European Special Situations, including charges

TM Crux European Special Situations key investor information

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More on Baillie Gifford European, including charges

Baillie Gifford European key investor information

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More on Legal & General European Index, including charges

Legal & General European Index key investor information

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More on Barings Europe Select, including charges

Barings Europe Select key investor information

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How have other European funds performed?

The IA Europe ex UK sector has returned 9.4% over the past year*, meaning the average fund has outperformed the market. It’s a similar story for the average fund in the IA European Smaller Companies sector. Again past performance isn’t a guide to future returns.

Broadly speaking we’ve found funds with a focus on ‘growth’ companies did best. Baillie Gifford is an investment group with a strong growth bias, and therefore the group’s European fund has been the best performing fund in the IA Europe ex UK sector this year.

On the other hand, 'value' focused funds, haven’t performed as well. So-called value or recovery investors aim to uncover hidden gems – companies whose share prices don’t necessarily reflect their actual worth or earnings potential. These businesses might have fallen on hard times, but could sometimes be undergoing a turnaround that’s yet to be reflected in their share price.

More recently in November, among news of potential vaccines, there has been a market rotation, with lots of value-focused funds performing better. Growth funds, including the Baillie Gifford fund, sit at the bottom of the pack, while lots of value funds are at the top of the pile.

This is over a short period and investment decisions shouldn’t be made based on one month’s performance. But it’s a reminder that different investment styles will come in and out of favour, and diversification in any portfolio is important.