European equities roundtable: Part 1

Looking beyond the gloomy headlines

Sonita Horvitch 22 October, 2012 | 6:00PM
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Editor's note: If you were investing according to the headlines, Europe might be about the last place you'd put your money. Yet European stocks have shown resilience this year, and the region is home to many world-class businesses, according to the trio of managers we convened for Morningstar's exclusive European equities roundtable.

The panelists:

 Paul Musson, senior vice-president and head of the Ivy team at Mackenzie Investments. Musson is the lead portfolio manager of a wide range of mandates including Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class.

 Chuk Wong, vice-president and portfolio manager at GCIC Ltd., which is the manager of the Dynamic family of funds. Wong's responsibilities include Dynamic European ValueDynamic Global Value and Dynamic Far East Value.

 Peter Moeschter, executive vice-president, Franklin Templeton Investments. Moeschter runs both global and EAFE (Europe, Australasia and Far East) portfolios for retail and institutional investors.

The discussion was led by Morningstar columnist Sonita Horvitch, whose three-part series this week continues on Wednesday and concludes on Friday.

Q: Europe's financial troubles are at the forefront of the International Monetary Fund's concerns about the health of and outlook for the global economy. There have been protests in the streets against the austerity measures introduced by the heavily indebted countries. Despite these hardships, the European equity market has done fairly well in the year to date. Can we discuss this?

Musson: In the first nine months of 2012, the MSCI Europe Index, the benchmark for European stocks, has closely tracked the MSCI World Index, the benchmark for equities in developed countries. Expressed in Canadian dollars, the total return on MSCI Europe is 8.4% versus 9.9% for MSCI World.

Peter Moeschter

Wong: The sovereign-debt crisis in Europe is massive and it is surprising to many investors that Europe year-to-date has performed in line with the world index, of which a big portion is the U.S. equity market, which has been a strong performer.

Musson: Some world-class businesses happen to be domiciled in Europe. For the most part, the European companies that we are invested in are multinationals. Top holdings in both Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class include Danone SA, which is based in Paris and has more than 50% of its sales in emerging markets. Likewise London and Amsterdam-based Unilever, which is also in the top 10 in the two funds, has more than 50% of its sales in emerging markets. These are examples.

Q: What of their sales in Europe?

Musson: It depends on what part of Europe you are talking about. It also depends on the kind of business they are in. Right now, even defensive-type companies are seeing a negative impact on their sales and margins in southern Europe, particularly Spain and Portugal. Yet, the Swedish multinational fashion retailer, Hennes & Mauritz AB, which operates the H&M stores, is showing strong sales growth in Greece.

Moeschter: Some of these companies have hit the right spot. H&M is aimed at the more value-conscious consumer.

Wong: Over the past two or three years, the stocks of European global companies have outperformed the MSCI Europe Index by a wide margin. Europe is made up of domestic companies, regional companies and global companies.

As a stock picker and value manager, I have seen a lot of under-appreciated European companies in the last couple of years. Some of these are global, best-in-class companies, yet they trade at low valuations. This is because they are listed in Europe. Like Paul, our focus has been on global champions. In my case, this is not necessarily the mega-caps. The targets are industry leaders with high market shares and strong balance sheets, which are benefitting from robust demand in their niches. We focus on strong business models.

Paul Musson

Moeschter: Sometimes it is those smaller- and mid-cap global companies that dominate their niches that are doing well. A lot of European companies are known for high-quality production and high-quality standards. I cover Germany for Franklin Templeton. A lot of German smaller-cap companies that are not necessarily household names, but do dominate their global niche and may have some 20% or 30% or more of their sales into Asia, are doing fine.

Wong: We have been focusing on continental Europe. If you look at the U.K., it has already replaced Japan as the second largest stock market in the world. Of course, it is still a lot smaller than that of the United States. What is significant is the structure of the U.K. market. It is very global. More than 70% of the revenue of the listed companies comes from outside of the U.K. and 50% comes from outside Europe. If you invest in a global company listed in the U.K., chances are that you are investing in a truly global company.

It is hard to see a lot of economic growth coming from out of continental Europe and the U.K., so these global companies are doing quite well elsewhere.

Moeschter: They are being encouraged to build their businesses in other countries, given the troubles in Europe.

Q: How did Europe land in this financial mess?

Musson: It is not just Europe. The United States, on a debt-to-GDP basis, is worse than a lot of European countries. Among the developed economies, Japan is the worst on a gross-debt-to-GDP basis. Europe is getting the attention because of the euro. The euro is still an experiment. It is the result of a monetary union, but not a fiscal union.

There were a lot of naysayers when the euro was launched, who said: "You can't have one without the other." You end up having a lot of resentment within this union as some feel that they are funding others. You have a monetary policy that might be appropriate for one country, but not for another. These issues are why Europe is front and centre in the headlines.

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Chuk Wong

The United States will be in the headlines in a couple of months, as we head towards the fiscal cliff. Generally, many economies have been living beyond their means for decades. The necessary fix is always painful.

Moeschter: The signs of problems in Europe were there for some time, but they were being masked by global growth. As soon as this slowed, it brought the problems to the surface. You had housing bubbles in a few countries, like Spain and Ireland. Fortunately, a lot of Europe, like France, Germany and Italy, did not experience this. But you started to see the cracks in Europe.

There was a lot of borrowed money and a rising standard of living on that borrowed money. There was no accompanying productivity or the production to support the standard of living. A country like Italy has made no improvements in productivity in the past decade.

By contrast, Germany adjusted its economy much earlier. It had to integrate East Germany in the '90s. It caused deflation in the labour markets and the integration was hugely costly to the economy. In the decade of the 2000s, Germany needed to bring down labour costs. Otherwise, the jobs would simply go to eastern Europe.

The Germans reduced their cost of production and reduced government expenditure. A lot of the benefits like the health-care system and pensions were changed. Unpopular decisions were made on the expectation that it would pay off down the road. It has done so. Germany has a 6% unemployment rate.

Wong: Spain has a 25% unemployment rate.

Moeschter: The financially strapped European countries are being forced to adjust more quickly than they would like to. It is painful. It is happening to a lot of countries at the same time. That is why you are seeing the protests and the headlines. To boost these countries' competitiveness, a devaluation of their currency would help, but they currently belong to the Euro zone, so it is not possible.


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Sonita Horvitch

Sonita Horvitch  

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