Nobody loves us, everybody hates us
Financial Publisher Citywire recently published the results of a survey of 400 fund selectors1, asking them where they expected to allocate in 2023. As European portfolio managers, it was ungratifying to read that almost nobody expected to allocate to European Equities. To understand why it is so unfavoured, we surveyed Federated Hermes’ own clients for their comments.
The main concern fed back to us was the muted economic growth prospects expected in Europe compared to other regions. Geopolitical challenges and structurally higher inflation were also flagged as issues, as well as the underlying so-called ‘uncompetitiveness’ of Europe. While we agree that these are all legitimate worries that should be incorporated into stock analysis, we would also counter that these do not guarantee underperformance for European markets.
To illustrate this point, the graph below shows nominal GDP for Europe, China, and India since the end of 2009 (chosen to coincide with our arrival at Federated Hermes). Since then, European GDP has barely moved, while India’s economy has more than doubled and China’s has more than tripled. Despite this, the MSCI Europe index has outperformed its Indian and Chinese counterparts, as shown in figure 2.
Figure 1: Nominal GDP (US$), rebased to 100
Source: World Bank / Federated Hermes, as at 2021.
Figure 2: Total returns (US$)
Source: Bloomberg / Federated Hermes, as at January 2022. Past performance is not a reliable indicator of future performance.
Of course, it is possible to select different date ranges to show each region’s performance in a better light and it is not our intention to suggest that any region is ‘superior’ to any other. We only want to point out that the European market is competitive and is worthy of consideration.
The market is not the economy
So, why is the performance of the European market not more closely correlated to economic performance of the region? Since the market is forward-looking and it is well-known that overall European economic growth is lacklustre, surely this should support a closer linkage? We can see why when we look at the individual companies.
Figure 3 shows the percentage of revenue generated outside of Europe for the largest listed companies. Collectively, these companies represent over 50% of the MSCI Europe index and, on average, generate less than one-third of their revenue in Europe. So, investing in European companies will typically provide a very diverse geographical exposure. Moreover, since these companies have a choice in where they choose to expand, they are going where the growth opportunities are most fertile.
Figure 3: Percentage of revenue generated outside of Europe for Europe’s largest listed companies
Source: Bloomberg / Federated Hermes, as at March 2023.
Europe breeds winners
- Infrastructure: Europe has excellent transportation, utilities and communications infrastructure. According to the Global Quality Infrastructure Index (GQII) programme2, five European countries rank in the top 10, and almost half of top 40, in quality infrastructure. European companies can focus more of their efforts on developing new products and sales channels, rather than overcoming logistical challenges.
- Educated workforce: European countries occupy 14 of the top 20 positions for Education rankings (annual Best Countries Report, conducted by US News and World Report, BAV Group, and the Wharton School3 ). The availability of a skilled and qualified workforce is a huge advantage for companies on the global stage.
- Wealthy population: While European economies may not be growing very quickly, they are wealthy on a per-pop basis, making them excellent markets to sell into. European countries represent 20 of the top 30 spots of financial assets per capita.4
- Stable political and financial environments: Per the Corruption Perceptions Index published by Transparency International, Western European countries represent 70% of the top 20 least-corrupt countries (with the USA ranking at number 24).5
It’s more global than ‘global’
The global stock market is not representative of the global economy.
Equities are the best hedge against inflation
So far, we have made the case for Europe – but what about the case for equities? Theoretically, rising interest rates would increase the WACC8 and reduce valuations. However, that should already be considered by using through-the-cycle assumptions of discount rate.
More importantly, during times of higher inflation, equities offer a natural hedge. Companies feel the pain of inflation through rising employee costs, rent, raw materials, and so on, but they also benefit from the higher prices that they sell their products for. However, not all companies experience inflation in the same way. Those that offer a high degree of value-add relative to the cost of their products find it much easier to push through price increases and are net beneficiaries. Conversely, those without pricing power will feel pressure on both the top line and the expenses line.
‘Take a chance on me’
If we return to the point made at the start of this article, there is an irony in fund buyers wanting fund managers that do not follow the herd (like us!) yet being unwilling to allocate to Europe at a time when it is unjustifiably out of favour.
‘So, if you change your mind, put us first in line. Honey, we’re still free – take a chance on Chi’ (and our Sustainable Europe strategies!)9
For more information on Sustainable European Equity and Sustainable Europe ex-UK Equity, please follow the links.
1 Citywire Amplify, ‘Where more than 400 fund selectors expect to allocate’, as at 6 March 2023.
2Global Quality Infrastructure Index (GQII) Program, as at 2021.
3 World Population Review, as at 2023.
4 Allianz Global Wealth Report 2022.
5 Transparency International, Corruption Perception Index, as at 2022.
6 MSCI Europe Index (EUR), as at 2023.
7 MSCI ACWI Index, as at 2023.
8 Weighted Average Cost of Capital.
9 Lyrics referenced in this piece have been taken from ABBA’s ‘Take a chance on me’ (1977).