A second look at European stocks

At a time when emerging market equities are the hottest ticket in town for private banking clients, advocates of European stocks are quietly trying to push an asset class which many believe lost its sparkle ten years ago.

Big banks, particularly the French and German juggernauts, lost mandates due to poor performance in the late 1990s, as the taste for active equity in core asset classes began to wane and first institutional and then private investors chose passive solutions within portfolios.

But with recent economic turmoil in Europe, there is in some parts a renewed focus on some of the Continent’s individual companies. “There is a big difference between economics and the stockmarket. The two are not quite as correlated as many people believe,” says Adrian Darley, head of European equities at £70bn (€81bn) investment house Ignis, a unit which has continued to evolve from the embers of the Britannia Life insurance company over the last 15 years, with several changes of ownership along the way.

Domestic economics is just one variable reflected in stockmarket performance over the last two decades, believes Mr Darley, formerly a senior fund manager with Gartmore, a rival UK house. He uses China as an example, comparing its economic miracle with poor long-term equity performance. “The more companies become global, the more the domestic economy becomes less relevant to market evolution.”

Even well run Greek companies have performed badly, he says, because of the economic background in Athens, as they are domestically focused, with minimal foreign exposure.

One reason why the European equities asset class is breaking out of the backwoods is the emergence of performance fees, says Mr Darley. He also has a strong belief that huge teams of analysts, carried by European equities departments during the class’ 1990s heyday, often hindered performance.

“There was a sense of competition between the fund houses, looking at who had the biggest analyst teams. But there is almost an inverse correlation between the number of analysts and performance,” he adds.

He gives the example of his ex-employer Gartmore, which had 17 European equity analysts in 2000, trimmed to just 3 by 2006, with analyst numbers often more of a marketing tool than a performance booster.

“There has been a lot of adjustment to buyside analyst capability over the last five years, right across the city,” says Mr Darley.

“This is partly about costs, but there is very little empirical evidence that they are a good asset in increasingly volatile markets. That is not to say that specialist knowledge is of no value, but I can call up Goldman Sachs, Merrill Lynch or Morgan Stanley; I can call numbers one, two or three in any sector and see them at any point in time, so why have them on my cost base? And I don’t need to manage them either.”

Among Mr Darley’s current sector favourites in Europe are financial institutions, without the co-operation of which he believes the entire asset class will struggle to progress.

While there are many weak players in the financial sector, it is important to differentiate them from the forward-looking banks such as Santander, DnB and BNP Paribas.

Santander, he says, has been buying up “distressed businesses” including UK high street banks Abbey National and Alliance & Leicester and has diversified away from its core Spanish market to increase earnings in both Latin America and the UK. “There is a valuation inefficiency there. It doesn’t mean all financial stocks are attractive,” says Mr Darley.

He is also keen on the wealth management sector and particularly Julius Baer, Zurich’s fast-growing bank, now making the two traditional leaders of UBS and Credit Suisse sit up and take notice of new competition. He praises the bank’s purchase of fund manager GAM from UBS, its eventual split between private banking and asset management business and the more recent buyout of ING’s Swiss wealth management franchise.

“They have enough excess capital to do another deal like that,” says Mr Darley. “The global demographics are working in their favour. They are also working in favour of Credit Suisse, but when you buy Credit Suisse, you also get a big investment bank and US issues. Julius Baer is the largest, purest play in traditional private banking and still attractively valued.”