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Why is Europe ‘cheap’ and where’s the opportunity? – 3 fund ideas

Europe is looking attractively valued right now but where are the opportunities? We look at the economic outlook, stock markets, and share 3 fund ideas.
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Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Even with a tight labour market putting pressure on inflation in 2023, it still fell in the euro area from 10.6% to 2.8%. Most longer-term expectations are now placing inflation around the target level of 2%.

The unemployment rate in November was 6.4%, the lowest it’s been since the start of the euro.

Earnings grew in recent months, which could help inflation stay higher. But not all companies are passing on rising costs to customers, which might instead keep it at bay.

This is a mixed blessing for investors – good news on inflation, but not so good for corporate margins.

Economic growth in Europe has also stagnated. Recent data is suggesting continued weakness in the near term and, while we’re expecting long-term growth to pick up eventually, demographics could mean growth is more subdued.

The population is close to its peak and expected to shrink later this century. And the working-age population is set to fall at the same time as the number of over-65s grows.

The bright spot for global growth is the productivity potential of artificial intelligence, but the scale and timing of this benefit are still big unknowns.

High levels of government debt are also still a concern. This creates a longer-term vulnerability – but aren’t an immediate threat.

What does this mean for investors?

This might sound gloomy for investors, however, the good news is that growth forecasts have been revised down. And that creates scope for positive surprises.

The European stock market is looking like good value right now. It’s below the global average, and at a historical low compared to the expensive US stock market.

This improves investors’ chances of finding a ‘bargain’ and could limit potential downside. But what about growth prospects?

Well, earnings are expected to grow modestly in 2024, while profit margins are at a 20-year high.

The Europe ex-UK market is well diversified by country and sector. France, Switzerland, Germany and the Netherlands are the biggest constituents.

The largest sector – financials – is only 17% of the index. And there are six industries represented in the 10 biggest companies. By contrast, seven tech-related stocks (‘the magnificent seven’) have dominated US market performance recently and now make up over a quarter of the market.

Europe is home to semiconductor equipment manufacture ASML, luxury goods producer LVMH, and food giant Nestle – some of the biggest companies in the world. But some industries are local to the 27 countries that make up the EU.

The US stock market has raced ahead of Europe over the last decade. Its economy, with its expanding population and dominant tech sector, will likely keep outpacing growth in Europe – but of course that’s not guaranteed. For now, though, valuations favour European shares.

This article isn’t personal advice. All investments, and any income from them, can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future. If you're not sure if an investment is right for you, ask for financial advice.

Where’s the opportunity? – 3 European fund ideas

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a long-term diversified portfolio.

For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Polar Capital European ex UK Income

Polar Capital European ex UK Income is different to many in the European sector because it’s offering an income and a more conservative investment approach.

It aims to deliver income greater than the MSCI Europe ex-UK index and grow investors' money over the long term, but with less volatility along the way.

The manager invests in bigger European companies they think are undervalued. These are companies going through a tough time or where the manager doesn’t feel the share price matches the longer-term potential and could bounce back. This is different from other European funds that focus on companies with high-growth expectations. As a concentrated fund, each investment could have a big impact on performance, which increases risk. The managers also have the flexibility to use derivatives which can magnify any gains or losses and increases risk.

Nick Davis, the fund’s lead manager, currently focuses on sectors like insurance, telecoms, and healthcare. These are defensive areas that pay an attractive income – the idea is that these companies tend to do well regardless of how the economy is doing.

The fund has a historical yield of 3.96%. Although remember, income isn’t guaranteed, and yields are variable and not a reliable indicator of future income. The fund takes charges from capital which can increase the yield but reduce potential for capital growth.

CT European Select

This fund focuses on growth instead of income. Benjamin Moore and David Dudding, the fund’s managers, look for high-quality, established European companies they think offer long-term sustainable returns.

This means the companies in CT European Select might not be as lowly valued as those in other funds, but they should still have strong growth potential over the long run.

The managers prefer companies operating in industries with relatively few competitors and with strong pricing power – the ability to pass on rising costs to consumers without denting demand too much. A competitive advantage that others struggle to replicate is another trait they like.

They currently focus on sectors like industrials, consumer discretionary and information technology, because of the promising opportunities they find. They avoid companies they believe don’t have as much pricing power, like real estate, energy, and utilities. They invest in a relatively concentrated number of companies, meaning each investment could have a big impact on performance, which increases risk.

This fund is a low-cost option for tracking the performance of the broader European stock market, measured by the FTSE World Europe ex UK Index.

Legal & General European Index invests in every company in the index and in the same proportion. This is known as full replication and helps closely match the performance of the index.

The fund is currently made up of 565 companies focused on sectors like financials, industrials, and healthcare. France, Switzerland and Germany make up a big part of the index, but it also features other countries like Italy, Spain and Denmark.

An index tracker fund is one of the simplest ways to invest. So this fund could be a great, low-cost starting point to invest in Europe in a portfolio aiming for long-term growth.

3 European share ideas

If you’re comfortable investing directly in company shares, we recently wrote about 3 European share ideas.

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Written by
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Robert Farago
Head of Strategic Asset Allocation

Robert works with experts across the business to set our asset allocation strategies for clients across HL. He and our experts help clients find, understand and stick with a suitable investment policy. He also leads the monthly asset allocation committee, where investors from different areas of the business come together to discuss the market outlook.

Kate Marshall
Lead Investment Analyst

Kate leads a team of Investment Analysts and is a member of the Senior Research Team. She provides oversight and challenge to fund selection across all sectors on the Wealth Shortlist, and votes on all proposals.

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Published: 29th February 2024