Investor confidence is growing in Europe

Investment flows into European equities funds are positive again after a milder-than-expected winter and successful efforts to build gas storage. J O Hambro’s PAUL WILD explains

• European energy crisis averted
• Euro fund flows return
• Many investors still underweight

INVESTMENT flows into European equity funds have returned after almost a year of withdrawals as the region’s prospects brighten amid mild weather, falling gas prices and a re-opening of Chinese export markets, says J O Hambro PM Paul Wild.

Russia’s invasion of Ukraine last February prompted global investors to start withdrawing money from Europe and 48 consecutive weeks of outflows left most investors underweight European companies.

A big driver of the outflows was fears that energy shortages would drive the region into recession.

But a rapid turnaround in sentiment on the back of a milder-than-expected winter and successful government efforts to build gas storage has seen investors once again turn their attention to the eurozone.

“Midway through last year, it looked like Armageddon as Europe was held to energy ransom,” says Wild, who manages JOHCM Continental European Fund.

“But now, gas prices are back below where they were before the Ukraine conflict, supply is plentiful, and it looks like it’s going to stay that way for the next year or so.

“I can’t say the uncertainty has disappeared, but certainly it has massively improved in an almost unbelievably favourable way.

“In the second half of this year, many consumers will be facing lower energy bills again.”

Russia previously supplied some 35 per cent of Europe’s gas — including half the gas needs of Germany and Italy — prompting a concerted effort to import liquified natural gas and build up storage reserves to counter Russian threats to cut supply.

But mild weather means Europe will exit the winter with its gas storage more than half full.

“That means for Europe to rebuild up to a 90 per cent plus storage level for winter 2023-24, it needs about 30 per cent less gas per day than it’s been importing over recent periods,” says Wild.

The reduction in forecast demand has sent natural gas prices plummeting more than 70 per cent from last year’s peaks.

The China factor

But Wild says the positive outlook for Europe is based on more than just energy prices, with the re-opening of China also buoying prospects.

“It’s estimated that European companies have on average about a 10 per cent revenue exposure to China, so the re-opening is very positive.

“Europe is home to lots of global companies, from the famous luxury goods companies to the big German manufacturers.”

The EU economy itself is also proving surprisingly resilient. Eurozone GDP numbers for Q4 were up 0.1 per cent, allaying fears of a recession.

The upshot for investors is that European stocks look attractive compared to global peers, says Wild.

“Europe has now outperformed the US over the last year but it is still trading below its average long-term PE levels.”

Rates close to peaking in Europe

Key to the positive outlook are interest rates which are expected to peak in Europe at about 3.25 per cent over the next few months.

This is driving improvements in earnings in interest rate sensitive sectors like banks which are seeing a return to growth after eight years of negative interest rates.

“Europe has been labelled as an area of perpetual underperformance.

“But people forget what an unusual period investing history we have been in since the GFC, with a significant decline in interest rates largely benefiting the US, which is significantly overweight technology.

“Things have changed now. With higher interest rates, the focus moves to value driven sectors and Europe is at the heart of many of those sectors like financials and industrials.”

Wild says the extent of the outflows through last year has left most investors very underweight European equities.

“Since 2016, European equity funds have lost about a third of their assets.

“So, it doesn’t need a sea change of flows for it to be significant.”

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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