Investing in European markets

To say that Europe has had a challenging few years is an understatement. The Great Recession was followed by another recession in 2013, then came threats of bank failures, country defaults, negative interest rates, a quantitative easing program and, most recently, Brexit. For one European-focused fund manager, these issues have made investing in the region increasingly difficult.

Currently, Matt Peden, lead manager of the Trimark Europlus fund, which has a five-star Morningstar rating, has about 20% of his assets in cash. Why? Because low interest rates and quantitative easing—the buyback of public debt to help spur growth in the area’s troubled countries—has caused high-quality stocks to rise without actually fixing the Eurozone’s problems.

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“A lot of those initial issues, from what started with Greece in the sovereign debt crisis and has spread to several other countries, have not been resolved,” says Peden. “The European Central Bank’s QE program pushed interest rates down to manageable levels which has alleviated a lot of pressure on governments, but it’s allowed them to avoid the structural challenges that brought them to the crisis point in the first place.”

While a lot of attention has been paid to Brexit lately, it’s not the biggest concern, he says. The market dropped in the days after the vote, but they’re now back to pre-Brexit levels because investors realize that totally exiting Europe is going to be a multi-year process. Peden is more worried about Italy’s growing problem with non-performing loans. People are simply not paying interest or principal on money they’ve borrowed and that’s putting immense pressure on bank balance sheets. If it gets worse, the country’s financial sector could be in real trouble.

But the main reason why he’s holding more cash is that the market looks expensive. Like in North America, low rates have pushed people into high-quality dividend paying equities, the kind of stuff that Peden likes to own. Currently, the MSCI Europe index is trading at 14.5 times forward price-to-earnings. The only time it’s been higher was when it peaked at 16.2 times in February 2015 at the start of ECB’s QE program.

However, all is not lost for diversified investors who want to own European stocks. Peden suggests looking at U.K. companies that have a domestic focus. A lot of attention has been given to Europe’s multi-nationals, which has left a number of well-run small- and mid-caps out of the limelight. “We’re finding better value in this space,” he says.

Peden is looking for businesses that generate at least 50% of their revenues from the U.K. and he’s finding those companies in the housing, real estate and industrial sectors. One company he likes is Electrocomponents, an Oxford-based distributor of electronics and automation components. It also develops, maintains and repairs electronics. It’s in the midst of a restructuring plan and has a new management team, which Peden likes.

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He would like to invest more in other sectors, but he’s waiting for a pullback. However, with the ECB essentially having to continue its QE program to keep the region’s problems at bay, he admits that he may have to wait for a while. “We’re quite content to sit on excess cash,” he says. “We’ll patiently wait out the market until we see more reasonable valuations.”

How to invest in European securities

For investors who do want to buy into Europe, there are plenty of options available, especially with ETFs. While people can buy broad-based European funds, such as the Vanguard FTSE Europe ETF, the largest European passive fund with $17 billion in assets under management, those who have a specific country view can narrow down by nation. The iShares MSCI UK Small Cap UCITS ETF, for example, gives investors exposure to those more domestic-focused operations.

There is also a plethora of mutual funds to choose from, but look at the long-term track record before buying. According to Morningstar, no European fund has returned more than 0.5% year-to-date, though several have done well over the longer term. Peden’s fund has 16.11% annualized five-year return, second only to the Dynamic European Value Series I fund, which has a 16.98% annualized return over the same time period.

Whether you decide to invest or not will, of course, depend on whether you think the ECB will continue to buy bonds and if its myriad issues will cause problems later on. Remember, it’s OK to take a wait-and-see approach for now. “Unprecedented central bank intervention in the marketplace has driven valuations to irrational levels,” Peden says. “People are just reaching for yield.”