Europe a relatively bright spot within active management

Since the global financial crisis, much has been said about the state of the European economy, but one story that has been lost in the headlines is that since the end of the crisis, Europe has been a pretty good spot to be an active stockpicker.

Indeed the percentage of managers that have outperformed over a rolling three-year time horizon has hovered near 50 per cent of the universe on an after fee basis. Once you take into account fees and commissions on an exchange traded fund (or other passive instrument), you are into the better than evens territory for picking an outperforming manager based on chance alone.

Overlay a disciplined process for selecting money managers on top of that, and one has stood a good chance of adding some material manager alpha for investors. In a five or six-year period that has been as difficult as we can remember for adding industry alpha, Europe in this sense has been a relative luxury. For example, picking the top quartile performing manager between 2009 and 2013 added 2 per cent of excess returns per year.

So what explains this relative success of European managers?

Generally speaking, the active management community tries to add alpha by stock selection, focusing on what is happening at the company level, making an assessment of a company’s worth based on competitor and industry analysis and making a judgement on the company’s management and their ability to be able to implement their stated strategy. This has become harder since the onset of the crisis, followed by the European sovereign debt crisis, as drivers of markets have been dominated by macro drivers. Given money managers can only play the cards they are dealt, this has caused investors and the portfolio management community to adapt and become quite top-down in its approach, finding a theme or two in their portfolio and riding its momentum. Successful managers have done this very effectively.

To outperform in Europe, investors needed to keep it simple, identify a few themes correct and stick with them. A focus on areas of the market with a more global or emerging market growth footprint certainly increased odds of outperforming, overweighting Germany, UK, and the Nordics. Successful investors avoided the more “domestic stories” and underweighted the real trouble spots: Portugal, Ireland, Italy, Greece and Spain.

An additional theme that rewarded many managers during the crisis was luxury goods; with many of the world’s leading luxury brands based and listed in Europe driven by newly wealthy emerging market consumers and their insatiable demand for luxury goods. Some of these names have doubled or even tripled in value since the crisis.

So what is in store for the future? Managers have done a pretty good job navigating through some difficult times. However I am sure they, like many of us, would appreciate an environment that feels a bit more “normal”. Perhaps an environment that feels like it used to, when managers and their analysts would focus the vast majority of their time on what was going on at the company level, rather than trying to second guess what ECB president Mario Draghi may or may not do.

We would recommend continuing to make use of managers that have been successful in navigating the macro environment but also to consider balancing part of one’s portfolio with skilled stockpickers suited to the environment looking forward. Certain styles of stockpicking have not been rewarded at all in Europe during the crisis – this does not necessarily mean they are broken, more they have not been positioned to capture the themes that have driven markets as outlined above. Understanding your managers and setting your own performance expectations is key – we would all like to have managers that perform consistently year after year, however these are difficult or indeed impossible to find. 

After the recent success of certain styles in Europe we think it is worth thinking about how to complement these highly successful managers with a more contrarian form of pure stockpicking style. In the aftermath of the US subprime crisis, the environment was ripe for skilled stockpickers with the right style and discipline, as the dislocation in the markets had left valuation spreads very wide between cheap and more expensive stocks – these managers tended to have more of a “value” bias in their approach. From an alpha opportunity standpoint, we think there are echoes and some similarities with what we saw in the US in 2009 with what we see in Europe today.  

Kristof Gleich, head of manager selection team, JP Morgan Private Bank EMEA