Europe is a popular destination for those interested in history, although typically tourists do not focus on artefacts from the period 2010 to 2016. Fund managers are another matter, however.
Fatigue from the US presidential election and British referendum on leaving the European Union appears not to have deterred investors, and nor have longer memories of the turmoil surrounding the possible collapse of the euro currency earlier this decade, despite a particularly crowded political calendar in Europe this year. Major votes in France and Germany are now joined by a surprise UK election in June, which was announced only in April.
In its April survey of global equity managers, Bank of America Merrill Lynch recorded the fifth-largest rotation from US equities to eurozone equities since 1999; their net overweight to Europe reached a 15-month high of 48%, up from 27% in March and 1.3 standard deviations above the long-term average. ‘Investors’ perception of Europe is increasingly bullish,’ commented Ronan Carr, European equity strategist at the bank. ‘Although we agree on the allure of Europe’s earnings recovery, complacency looks extremely high.’
Those managers were flocking to Europe despite being well aware of the series of risks facing the continent. Indeed, 13% expected a rate hike from the European Central Bank this year and around 75% in 2018; the last time the bank raised rates, in 2011, the market crashed. Also these professional investors still deemed European disintegration the greatest tail risk facing global markets, with 23% citing it compared with more than 30% in March.
It’s also worth noting, of course, that there is no perfect correlation between political risk in Europe and equity performance. In 2013, for example, Europe faced a contentious election in Italy and the bailout of Cyprus but the MSCI Europe index still returned 28% in dollar terms. The index also delivered 7.6% in the first quarter of this year despite the reigning uncertainty.
A limited continental buffet
While investors can find many reasons to be optimistic or pessimistic about European equities, their ability to express those views is more constrained. There are around 700 US equity exchange-traded funds (ETFs), but fewer than 100 for Europe.
The MSCI Europe index is admittedly smaller than its US equivalent – with a total market capitalization of $8.3 trillion across 446 constituents whose average size is $18.5 billion, compared with a total $21.3 trillion for the MSCI USA index over 627 stocks of an average size of $34 billion – but could justify more products, unusual in a generally saturated ETF marketplace. Two obvious omissions are momentum and value strategies for European equities, although there are such factor ETFs listed in Europe itself.
There are nevertheless a few smart beta options for Europe available in the US, leaving aside the popular dividend and currency-hedged ETFs. Despite the lack of single-factor ETFs – apart from a minimum-volatility offering from iShares – there are several multi-factor products. Their respective performances emphasize the importance of understanding their underlying methodology.
Ceci n’est pas un factor
Each of the Global X Scientific Beta Europe, Goldman Sachs ActiveBeta Europe Equity, and JPMorgan Diversified Return Europe Equity ETFs blends factors in a different way. JPMorgan’s fund targets value, quality and momentum, while Goldman Sachs adds low volatility to that trio and Global X replaces quality with size. Each also has its own weighting process and costs, ranging from Goldman Sachs at 0.25% to JPMorgan’s 0.43%.
Returns therefore vary significantly. Over the year to the end of March, the JPMorgan index gained 5.7%, Global X 6.6%, and Goldman Sachs 8.6% (they all have mandates including the UK and Switzerland, so that does not explain the differences). During the same period, the MSCI Europe index returned 9.8%, demonstrating that multi-factor exposure does not guarantee superior performance over shorter timeframes.
Allocations to low volatility were the primary culprits over the past year, while JPMorgan was not sufficiently geared to value. The First Trust Europe AlphaDEX ETF, by contrast, draws only on growth and value factors. Even with its higher expense ratio of 0.8%, it outperformed the broader European market over the same period, returning 11.4%.
Constant exposure to factors nevertheless helped those portfolios relative to a more unconventional strategy, the Pacer Trendpilot European Index ETF. This rebalances toward US treasuries when European equities fall behind their 200-day moving average and, despite excluding the underperforming UK and Swiss markets, returned just 5.1% in the year to the end of March.