Global investors are currently weighing up the prospects of recession, which has led to heavy losses on equity markets so far in August. Germany is one of the biggest worries after a 0.1% contraction in the second quarter that has led many economists to forecast recession for the Eurozone’s biggest economy.
Since the Greek crisis, investors in European equities have become used to a bumpy ride, with some years of strong returns – 2017 was a highlight when the region outperformed – followed by a lurch downwards in the second half in 2018 and subsequent recovery this year.
Jason Hollands, managing director at Tilney, says Europe faces a triple challenge: it’s exposed to a China slowdown, its dominant car sector will be hit by US tariffs on EU cars, and of course there’s the potential for a no deal Brexit at the end of October.
With the regional outlook darkening, which funds can investors back to see them through a possible slowdown and beyond? Hollands stresses that investors should shun funds that are heavily exposed to domestically-focused, cyclical sectors and financials and back those backing EU brands with a global reach such as luxury goods firm Moncler. Columbia Threadneedle’s David Dudding told delegates at the Morningstar Investment Conference this year that investors should look at the EU’s biggest brands like LVMH and try to ignore the often sickly economy data.
Michael Browne, manager of the Legg Mason Martin Currie European Long/Short fund, says there are many solid, cash-generative European firms, but whose share prices are likely to fall if economic conditions turn down. These businesses may suffer short-term dips (which Browne can profit from with short positions) because they are cyclical in nature, which is different to those with structural or management problems, which may not bounce back.
Avoiding Cyclical Firms
Tilney’s Hollands backs BlackRock European Dynamic, which invests predominantly in large and mid-cap growth stocks, and he thinks Crux European Special Situations is worth considering for more defensively-minded investors. The fund, run by Richard Pease, invests in companies that have strong pricing power, high barriers to competition and generate decent dividends, but avoids commodity firms, banks and those firms with high regulatory risks.
BlackRock European Dynamic has a Bronze rating and five stars from Morningstar. Analysts say the fund has had growth bias since 2011 – a style of investing that has outperformed value in recent years – and it has outperformed its benchmark and category since 2008.
Crux also has a Bronze rating; Morningstar analysts praise the fund’s consistency of management and approach. Richard Pease left Henderson to set up Crux in 2015 and is one of the UK’s most well-regarded fund managers, with nearly three decades of experience in European equities. Abu-Habsa says: “Over this time he has demonstrated robust stock-picking skills, following a disciplined process that is predominantly bottom-up.” Pease told Morningstar’s Holly Black that markets have faced a number of headwinds in the last 10 years but have handled these reasonably well.
Gavin Corr, managing director of Morningstar Manager Selection Services, is looking for funds that could weather a storm in the region, which may appeal to more bearish investors. The Gold-rated Comgest Growth Europe fund, has a strong team with a time-tested growth strategy, making it a good choice for investors who can take a long-term view, according to Corr.
“The team seeks quality companies capable of growing independently of the economic cycle which has been beneficial as economic growth expectations have been falling,” he adds. Like the Crux fund, Comgest avoids companies with the most cyclical exposure, including financial stocks.
Managers Alistair Witter and Pierre Lamelin seek out companies that fit in with Morningstar’s definition of a moat or sustainable competitive advantage, investing in firms with a dominant industry position, solid management and sound balance sheet. “The team favours sectors such as consumer, technology or healthcare in which companies can more easily build a strong competitive advantage and offer durable growth,” Corr says.
The fund is not an “all-weather” choice, Corr says, but offers better protection in downturns, as shown by its performance during the financial crisis.
Corr also likes the Silver-rated Schroder European Fund. “We are keen to ensure that we are invested with managers that can tread carefully in these uncertain markets,” he says. Experienced manager Martin Skanberg runs the fund in a “style agnostic” manager, which means he can take either a value or growth strategy. “This approach is arguably appropriate given the uncertainties that are prevalent across markets where long-term visibility is low,” Corr says.
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