2018 Isa fund tips: Europe’s no longer contrarian, but there’s still money to be made

After years of economic uncertainty, Europe’s fortunes appear to be back on the up once again. ‘From an economic viewpoint,’ says Darius McDermott, managing director at Chelsea Financial Services, ‘the outlook for the economy as a whole is healthier [than in recent years]’. Adrian Lowcock, investment director at Architas, concurs: ‘The region remains in the recovery phases of the economic cycle,’ he says.

According to International Monetary Fund forecasts, the eurozone should see 1.9 per cent growth in GDP during 2018. Other economic indicators are also looking positive. ‘Having worried about deflation for most of the past five years, inflation in the eurozone is now coming through,’ says McDermott. Consumption is also rising, alongside employment numbers. ‘Those upturns extend to some of the “Club Med” countries, which include Portugal, Spain, Italy and Greece, [albeit they are] starting from a historically low base.’

Oliver Smith, portfolio manager at currency trader IG, believes these improving indicators should ‘be positive for share prices as and when they feed through into company earnings’. Meanwhile, European markets are still undervalued. ‘Europe looks cheap relative to the US, and some of that valuation gap must eventually narrow with Europe no longer in crisis mode,’ says Smith.

McDermott agrees, noting that ‘compared with the UK and the US stock markets, valuations of European companies look more attractive and, importantly, earnings are starting to rise’. Sectors that often benefit from increased capital expenditure, such as industrials and some IT businesses, should do well, says Lowcock. ‘Capital expenditure has been muted for a long period,’ he adds, ‘so depreciation of assets, infrastructure and IT should make expansion quite likely. We are starting to see this trend as corporate loan demand starts to pick up quite nicely.’

-Will markets continue to rise in 2018? Five signals to keep an eye on

In contrast, Lowcock advises avoiding businesses in the consumer staples sector. ‘It is richly valued and the earnings expectations priced in are quite aggressive compared with what has been delivered historically,’ he says.

However, John Bennett, fund manager of Henderson European Focus trust, says there’s still value to be found in the sector. While he is also pessimistic about consumer staples generally, noting that the sector ‘doesn’t offer great value’, he believes there is one great opportunity in 2018: Carlsberg, the brewer. ‘The opportunities I see are very much stock-specific,’ he says. ‘It is one of our biggest positions.’

Don't get complacent 

Despite the improving macroeconomic situation in Europe, structural weaknesses still remain. ‘Inflation is still below target, unemployment is still too high and eurozone banks are far from out of the woods,’ notes Russ Mould, investment director at AJ Bell. It would therefore be unwise for investors to become too complacent, he warns.

In particular, there are some potential political flashpoints ahead. At the time of writing, Angela Merkel and her Christian Democratic Union have been unable to successfully negotiate a new coalition following Germany’s 2017 election. This may force Germans back to the voting booths. While another Christian Democrat victory would be likely, the anti-EU party, AfD, could make further electoral gains after its surprise showing in 2017.

Italy will hold an election in May 2018. This will be ‘the next big test for the European dream’, says Mould. At the time of writing at the end of November, the populist Five-Star Movement, led by Beppe Grillo, was leading in the polls, while former Italian prime minister Silvio Berlusconi had started to stage a political comeback. Both parties, while not advocates of leaving the EU, could upset the EU’s still delicate political balance.

Over 2018 investors should also monitor European Central Bank policy. Mould says: ‘[ECB president] Mario Draghi is slowly dialling down monetary stimulus. Quantitative easing is to be cut from €60 billion (£44 billion) to €30 billion a month, but it will run to at least September 2019.’ Mould is watching whether or not this pushes bond issuers ‘back into financial distress, to the detriment of the wider EU economy’, once the ECB starts to reverse its bond-buying programme. 

Fund and trust tips for investing in Europe

JOHCM Continental Europe (core growth)

TR 1 year 20.7%, 3 years 42.6%, yield 1.1%

Europe may no longer be a contrarian bet, as the continent’s equity markets have enjoyed a strong run in 2017. Its economic recovery has been gathering momentum as companies upgrade their earnings forecasts. But, according to John Husselbee, head of multi-asset at Liontrust Asset Management, for those who pick a fund with a value style such as this one, it is not too late to profit. ‘Value investing has lagged and perhaps off ers better value,’ he says. 

Invesco Perpetual European Equity Income (growing income and growth)

TR 1 year 24%, 3 years 42.3%, yield 2.9%

Another value fund that may be a good bet for those increasing exposure to Europe at the start of 2018. The fund was tipped last year by Alan Steel, and he is once again backing it to ‘benefit from positive sentiment surrounding European equities’. On a one-year view the fund is up 24 per cent, in line with the average rival fund return. But bear in mind that the sector mostly contains growth rather than income funds.

Ennismore European Smaller Companies (adventurous growth)

TR 1 year 9%, 3 years 34.7%, yield 0%

A less familiar name, but a strong pedigree. According to Mick Gilligan, this long/ short equity portfolio continues to generate very steady returns with low volatility from medium and smaller companies across Europe. ‘If we see an increase in profit warnings, we would expect to see better performance in the fund’s short exposure,’ he adds.

JPM European Smaller Cos (JESC) (adventurous growth)

SPTR 1 year 51.8%, 3 years 117.1%, discount -4.7%, yield 1.1%

Although JESC has performed strongly over the last three years, its discount remains wider than that of its main competitor TR European Growth. Investing in a mix of undervalued and growth companies, with substantial exposure to consumer discretionary, industrials and technology companies, it has capitalised on the pick-up in growth fl owing through to company results. Jean Matterson is positive on the basis that ‘the ratings on the companies are not expensive, so I see scope for good earnings growth and a re-rating of the stocks’. Tim Cockerill also makes JESC one of his picks.

Baring Emerging Europe (BEE) (adventurous growth)

SPTR 1 year 28.8%, 3 years 53.5%, discount -9.9%, yield 4.1%

Baring Emerging Europe has a better one- and three-year record than its closest peer, BlackRock Emerging Europe, but trades on a wider discount. It invests predominantly in fi nancials, energy companies and consumer staples in Russia, Poland, Turkey, Hungary, Greece and the Czech Republic. John Newlands is attracted by its unusual remit, its reasonable yield, and the fact that Matthias Siller has managed it since 2008. 

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