European equity funds provide rich pickings

Home bias is seen everywhere when it comes to investing, for better or for worse. For European investors, this bias has shifted from a pure country preference to a pan-European focus. Though the European bias might be much of an old habit rather than a thoughtful decision, when it comes to investing in funds there are at least three sets of good reasons why it makes sense keeping at least some of this bias.

Quite paradoxically, the European stockmarket is declining in terms of market capitalisation and this is a good reason for fishing in it. For years, investors’ interest in buying European stocks has been gradually decreasing: Europe is widely seen as an ageing, declining area, in contrast with the emerging regions. As a consequence, Western European stocks in aggregate represent a smaller market capitalisation than emerging Asian stocks. The silver lining is that smaller, less arbitraged markets tend to be more inefficient and therefore tend to provide more opportunities to outperform, which is at the core of active management.

A second reason why European stocks are quite a rich area for funds pickers is the depth of the offering. While the huge number of European funds is often put forward as a proof that the market remains to consolidate, the concern is much more for asset management firms than for fund selectors. There is an approximate population of 1,500 Ucits funds investing in all sorts of European equity, according to Morningstar, which allows investing with many different biases, styles, themes, countries and market cap sizes. Though the proportion of funds outperforming the index hardly went above 50 per cent any single year from 2006 to 2011, this is higher than for most other asset classes, notably US and emerging markets equity funds. Only 16 per cent of US equity funds outperformed the S&P 500 and only 39 per cent of emerging markets equity funds outperformed MSCI Emerging Markets during the same period.

The last set of reasons why picking funds in Europe makes sense can be labeled ‘propinquity’. Past performances and databases in general do not tell us the most important thing investors are looking for: future performance. This will never be found in any report, unfortunately. The best way of having an idea about future performance is getting in touch with the fund managers, visiting them on site and talking to them, cross-checking references and getting insights from other clients or competitors fund managers. As European investors, we are prone to visit more often fund managers located in Europe than elsewhere. This proximity enables to gather background information more easily about firms and individuals.

In light of above, it is important to be aware of specific factors when it comes to selecting a European equity fund manager. Obviously, the fragmented nature of the European stockmarkets and the continent itself is a key element.

True, a fund manager usually has access to research on companies listed across the continent. However, when interviewing an active, pan European equity fund manager, we have to assess to what extent he is able to properly analyse listed companies: there can be hurdles in terms of gaining access to management, their ability and time to travel on site, and language. If English is fluently used across blue chip companies, local languages become useful again when you dig a little bit deeper below the biggest market caps. Then, having several languages within the fund management team makes a big difference if the fund manager claims to run an all-caps fund.

In many cases, particularly true with boutiques, this depth of human resources cannot be found and you end up with a country biased portfolio. A Dutch, French or German fund manager will tend to invest more in his home country, which is not a show-stopper, but, as a fund selector, you must be aware of this.

The fragmentation of the regulatory framework in Europe can raise issues for the fund managers’ workload as well, as they often find themselves to manage slightly different portfolios for different sets of investors to meet different country regulatory requirements. Fund selectors must make sure that the fund managers’ attention is not split between too many portfolios. This is typically one reason why there are so many European funds as compared to their US-registered counterparts.

Despite, or rather because of, the continuing dislike of investors for European stocks, this area provides fund selectors with a vast array of opportunities, packaged in a suitable legal structure and enabling investors important proximity with the fund managers.

Bernard Aybran is head of manager selection at Invesco