Sector Focus: A very un-european European Fund

A few years back Europe was generally considered the sick man of the global economy. Thanks to poor demographics and excessive regulation the region would struggle to keep up with its free-wheeling Anglo Saxon competitors, or so the argument went. In the intervening period Europe has done much to defy the pessimists. Led by a resurgent German economy, the Eurozone outgrew America in 2006/7, with the growth rate peaking at 3.2%. Indeed, such was the turnaround which many came to believe that Europe could continue to thrive even if America experienced a slowdown.

We were always sceptical about such theories and the recent poor performance of European equities would suggest that many others have come to a similar conclusion. There is no doubting the fact that Germany, having locked into the euro at too high a rate, has done well to price itself back into contention. However, there are many others who have done the exact opposite. Furthermore, it would appear that a good proportion of Europe’s growth has come from unsustainable sources: exports to the overheated economies of Eastern and Central Europe; property bubbles, some of which are now in the process of deflating and increased government spending. In short, Europe has experienced a cyclical upturn, but the underlying negatives remain.

European equity indices are dominated by companies that sell to western consumers, companies that are likely to find the going increasingly tough in the future. On a cyclical basis it seems likely that Europe will experience slower growth in the period ahead, as property bubbles deflate and the strong euro starts to bite. The high cost of fuel is an added problem. Even if one looks beyond this tricky phase the prospects are not great. It appears that Asia’s era of exporting deflation has turned and it is now serving to increase prices and lower living standards for the Western consumer. The most evident example in this regard has been commodity price inflation. First it was the cost of fuel and now food prices are going through the roof.

And things are unlikely to get any better. It seems likely that either Asia will revalue its currencies (thereby raising export prices directly) or its inflation problem will worsen, thereby leading to the same result over a longer time frame. The strong euro has helped to suppress some of this imported inflation, but given that it is now overvalued, it is unlikely to play this role going forward. A weaker euro will make the situation worse.

That does not mean that one should not invest in the region as a whole. The renaissance of Germany is throwing up opportunities whilst the healthier economies of Scandinavia are also a good place to look. And on the other hand, Europe’s underlying weakness also creates something of an opportunity. Lacklustre domestic demand has left the region particularly reliant on exports for growth. There is an increasing international influence on European regional investment.

Just as Asia’s development is creating problems for some (i.e. anyone that sells to the European consumer), it is also creating huge opportunities for others. Anyone who is able to supply goods that Asia needs is actually doing pretty well. In addition high commodity prices are a boon to ancillary industries, like agrichemicals, oil services and infrastructure. It is also encouraging investment in alternative energy sources.

These are trends that we think will persist for many years to come. The surge in raw materials and energy prices is an unambiguous sign that demand is pressing against the constraints of supply. Over the last fifty years, the population of the world has surged from 2.5 billion in 1950 to 6.7 billion now.. The World Bank has estimated that the consumption per capita of the middle and upper income economies has increased by more than 200%. Human demand for these ‘finite’ resources has risen almost five fold over the last five decades.

In order to accommodate the shifting trading routes of the world, find and recover the necessary resources and drive forward the research required to develop alternatives, the world needs to invest significant sums of money.

With approximately 750 metals and mining, oil related and agricultural related stocks listed in Europe, exposure to the commodity market is significant. For example, mention oil wealth and people think of the Middle East – what they forget is that Norway is a major benefactor from the quest to find and drill more oil. It is the world’s third largest exporter of oil and gas and possesses some of the most advanced exponents of frontier drilling in the world.

In other words, to make the best out of European equity investment it is necessary to focus on companies which are positioned to benefit from this very exciting Asian development story – either directly or indirectly – and to be very wary of companies that are over-reliant on the European consumer. Unfortunately, the main indices and performance benchmarks are heavy on the second category and light on the first. Hence, if investment managers want to thrive in this environment they must be both willing and able to ignore what is in these indices.

At Ashburton we have long believed in the benefits of unconstrained and active management and in light of the huge changes afoot in the global economy, we think that it is more relevant today than ever. Indeed, the success of our European Equity Fund (and our other equity funds for that matter) owes much to its ability to invest in this way. In the past three years, it has outperformed the MSCI Europe Index by 62.6% and is the number one fund in its peer group. And this was a relatively benign period for the domestic European economy. The next phase is likely to be a whole lot tougher for index-huggers.

Key Points

• On a cyclical basis it seems likely that Europe will experience slower growth in the period ahead, as property bubbles deflate and the strong euro starts to bite.
• Norway is a major benefactor from the quest to find and drill more oil. It is the world’s third largest exporter of oil and gas and possesses some of the most advanced exponents of frontier drilling in the world.
• Anyone who is able to supply goods that Asia needs is actually doing pretty well.
• In order to accommodate the shifting trading routes of the world, find and recover the necessary resources and drive forward the research required to develop alternatives, the world needs to invest significant sums of money.
• To make the best out of European equity investment it is necessary to focus on companies which are positioned to benefit from this very exciting Asian development story – either directly or indirectly – and to be very wary of companies that are overreliant on the European consumer.
• At Ashburton we have long believed in the benefits of unconstrained and active management, but in light of the huge changes afoot in the global economy, we think that it is more relevant today than ever.

By Richard Robinson and Peter Lucas

Richard Robinson (pictured above) heads up the Ashburton European Equity team and gives an insight into why unconstrained active management can mean success in unexpected areas.

Peter Lucas (pictured above) is Ashburton’s Global Investment Strategist