Investors have been de-risking portfolios by “excessively” dumping European equities in recent weeks but a likely strengthening in economic data and sentiment means the asset class has a strong short-term outlook. 
That’s the view of FE Alpha Manager Rob Burnett, who believes this will drive his £390m Neptune European Opportunities fund towards the top of the IA Europe Excluding UK sector by the end of the year. The four FE Crown-rated portfolio is currently one of the peer group’s worst performers over 2018-to-date.
Explaining the conditions facing European equities in 2018, the manager describes the year so far as being one of “two extremes”. It started with investors having high hopes for the continent’s economy and markets after 2017 was “so far above expectations”, but this soon gave way to more muted sentiment.
Performance of fund vs sector and index in H1 2018
Source: FE Analytics
“What we’ve have this year is, in a way, a normalisation of growth. While the economy is going quite well, the PMIs have fallen from quite elevated levels. As that normalisation has taken place, investors have gone to the other extreme and become unduly despondent about the outlook for Europe,” the manager said.
“Because we have this late-cycle anxiety that’s prevalent across global markets everywhere, people are very sensitive to any sense of a slowdown because they think the cycle is very late. That, from my perspective, led investors to excessively de-rate a lot of stocks that have cyclicality in their business.”
However, Burnett has a very bullish view on the second half of 2018, when he expects investors to return to European equities as the economic data confirms that the region is experiencing relatively healthy growth.
“I am extremely optimistic about the second half of the year. In this scenario, fundamentals are solid – we’re not expecting an acceleration but we’re not expecting a deceleration – but the market has priced-in a significant deterioration in the outlook,” he said.
“I do think the fund will finish the year strongly and I do think this could end up being a decent period of performance for us.”
Neptune European Opportunities is a value fund and has overweights to more cyclical areas of the market such as banks, materials and car manufacturers. It has a zero weighting to sectors such as information technology and consumer staples, which have led the market for much of the past decade.
FE Analytics shows that the fund has performed very well when cyclical stocks have rallied. Over the past 15 years, there have been 20 quarters when the MSCI Europe ex UK Value index has outperformed MSCI Europe ex UK Growth and the Neptune fund was in the first quartile for 11 of them; it was second-quartile in three of these quarters.
“I think we are in a very good position between right now and the end of the year because we’ve had huge redemptions out of European equities, we’ve had significant corrections in some of the cyclical components of the equity market and sentiment is pretty poor as investors are nervous,” Burnett explained.
Quarterly performance of European value and growth indices over 15yrs
Source: FE Analytics
“From our perspective, the data is already beginning to stabilise. Simply a stabilisation of the economic data should be sufficient to get investors back into Europe and buying some of those cyclicals. It’s just one of those short-term entry points that the market throws up periodically when sentiment jumps too far in one direction. I think everything is a bit too pessimistic about the cycle, economic momentum, earnings and probably even about Trump and tariffs.”
The manager highlighted banks and auto makers as the two areas of the market that he is most confident on over the long run. Some 30 per cent of the fund is in banks, including UniCredit, Banca Intesa Sanpaolo and Commerzbank; it also has around 14 per cent in auto makers, with Volkswagen, Continental, Daimler and Renault sitting in its top 10.
However, these sectors were the ones that were hit hardest in the second quarter of the year. Banking stocks fell in the run-up to Italy’s constitutional crisis and when the ECB pushed out interest rate hike expectations, while autos have been hurt as investors worry about the impact of potential global trade war.
That said, Burnett expects these two sectors to be some of the strongest performers over the year as a whole, as confidence in the economy returns and investors realise that there could be positives to Trump’s tariff threats – such as the US and the EU agreeing to level the playing field and remove tariffs on car imports.
Another reason the manager remains confident is his view that the value style of investing can act as a contrarian hedge when market leadership changes – something that investors are widely talking about as the era of quantitative easing comes to an end and valuations look high in some parts of the market.
While many consider value to be a riskier style of investing, Burnett noted that it has outperformed in a number of bear markets including between 2000 and 2002. This suggests value can benefit investors on both the upside and the downside.
“It’s hard to say if anything is definitely in a bubble but we do know that investors are very overweight areas like tech and there are elements of the stock market that look very expensive. Tech has obviously been the leader of the stock market for the past decade and if you are anticipating a change in the investment regime, it has always paid historically to focus on the areas that have been shunned,” he added.
“That’s where we are invested at the moment: we’re looking at the areas that have not performed over the past 10 years and have suffered in this disinflationary post-crisis period. Our perception is that you can successfully hedge yourself by being very focused on price.”
Performance of fund vs sector and index under Burnett
Source: FE Analytics
While Neptune European Opportunities has struggled over 2018, FE Analytics shows that it has a very strong long-term track record. Since Burnett took over the portfolio in May 2005, it has generated a top-quartile 289.97 per cent total return – making it the 12th best performer out of 56 funds.
It falls into the bottom quartile over 10 years but is only 1.75 percentage points behind its MSCI Europe ex UK benchmark over this time frame. The fund is in the third quartile over five years and the top quartile over one year; it is ahead of the index over both of these periods.
Neptune European Opportunities has an ongoing charges figure (OCF) of 0.97 per cent and is yielding 1.71 per cent.