Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 159

The investment case for Europe

While most Australians think of Europe as a great holiday destination, it probably remains under-appreciated as an investment opportunity by many investors. After all, Europe comprises a wide range of countries with differing cultures and business climates. The region’s economy has also struggled in recent years with relatively low growth and stubborn price deflation, and debt problems in countries such as Italy and Greece.

Europe offers a potentially good investment destination and diversifier for Australians. Thanks to the continued growth in the Australian exchange traded fund (ETF) industry, it has never been easier for Australians to get exposure to European companies.

Europe’s equity performance has been surprisingly good over the medium/long-term

Although its economies have continued to struggle of late and the European equity markets have pulled back over the past year, it has performed relatively well in recent years and its medium-term prospects remain favourable. As seen in the table and chart below, the Wisdom Tree Europe Hedged Equity Index (in local currency terms) has produced annual compound returns of 7.4% p.a. over the three years to April 2016, compared to 5.0% p.a. for the Australian S&P/ASX 200 Index.

Europe v S&P/ASX200 Total Return equity performance to 29 April 2016, local currency

 

Unlike Australia, Europe is a net commodity importer, meaning it has benefited from the decline in commodity prices in recent years. What’s more, due to low inflation and relatively more spare capacity, the European Central Bank is likely to remain more accommodative than the US Federal Reserve for the foreseeable future, meaning European stocks could benefit from ongoing monetary stimulus and a cheaper and more competitive currency.

Relative valuations for Europe are relatively attractive

Relative to underlying growth in their respective economies, the European equity market appears to offer comparably good value to that of the United States. As the chart below suggests, although both markets have broadly posted similar performance over past cycles, the US equity market has outperformed that of Europe in recent years. There is catch up potential in Europe should the historical performance similarities return in the future.

Good dividends and scope for better profitability in Europe

Another feature of European equities is that companies in the region tend to pay out higher dividends than their US counterparts, meaning they offer one of the better sources of income potential for Australian investors seeking international equity exposure. On some profitability measures – such as return on equity and profit margins - European companies still tend to lag US companies, so there’s scope to improve earnings as companies strive to improve shareholder value.

A source of diversity

There is value in having a diversified portfolio, and Europe offers different sector exposures from those found in Australia, with notably less weighting to financials, offset by more exposure to the consumer, industrial and technology sectors.

An investment in Europe is easier than ever

The growth of ETFs has made it easier to invest in Europe, with several products available on the ASX providing Australian investors with a diversified exposure to the European equity market in a single, transparent fund with competitive management costs. For example, the ASX-traded ETF, HEUR, aims to track the Wisdom Tree Europe Hedged Equity Index.

When investing internationally, investors have a choice to either hedge or not to hedge currency risk. Not hedging currency risk effectively means investment performance will often reflect two disparate factors: the performance of the international equity market itself, and the performance of that market’s relevant currency. In the case of an unhedged investment in Europe by Australian investors, for example, any returns from the equity market would be offset to the extent the Euro fell against the Australian dollar – though, of course, returns would also be boosted if the Euro rose in value.

Another advantage of currency hedging in Europe with very low (in fact currently negative) overnight interest rates is that it gives Australian investors the ‘carry trade’ (i.e. the relative difference between European interest rates and those in Australia). This carry trade currently provides approximately 2.25% per annum benefit. The interest rate differential boosts returns over time (so long as the interest rate differential remains positive). This is because the process of hedging currency risk is akin to borrowing Euros (at very low rates) – to offset the currency exposure from the investment in European equities – and then using these borrowings to buy Australian dollars which earn a higher interest rate return.

 

David Bassanese is Chief Economist at BetaShares Capital. This article is general information for educational purposes and does not address the specific needs of any individual investor.

 

RELATED ARTICLES

ETFs playing bigger role for investors

The challenges of building a lazy portfolio

Know your fund types and structures – an acronym odyssey

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.