Europe is good, but is the US better?

With US-focussed international funds earning 30-35 per cent return in the last one year, fund houses have been turning their attention to Europe, the turnaround story of this year. The latest to offer one is Franklin Templeton, with its feeder European Growth Fund.

The fund house makes a case for investing in Europe on three factors. One is global diversification. Europe, accounting for nearly a fourth of world market cap and GDP, is too large to ignore. Two, corporate fundamentals in Europe have revived with companies there topping off 1.8 per cent earnings growth in 2012 with 7 per cent in 2013. Three, European companies are global leaders in engineering, pharma, telecom and many other sectors, which is why the large companies in the region are also the world’s top exporters.

Your investments in rupees will be converted into euros and invested in an already operational fund — the Franklin European Growth Fund. This fund is a bottom-up stock picker, looks for companies with a wide ‘moat’ (competitive edge) and is free to invest in stocks across market capitalisations. The overseas fund has managed a 19.2 per cent return in one year and 17 and 23 per cent annualised returns over three and five years. (Do note that this return is denominated in euros). The fund’s top sector weights were in consumer discretionary (26 per cent), industrials (22.5 per cent), financials (16.5 per cent) and energy (12.9 per cent) in end-March 2014. The fund is managed by Michael Clements.

Franklin Feeder European Growth fund offers dividend, growth and direct options and carries an exit load of 1 per cent if redeemed within 18 months.

The new fund offer closes on May 9 but the fund will, thereafter, be available for continuous purchases and sales.

Turnaround : The highest stock market returns are usually made in turnaround situations and the European region certainly is in one.

The IMF expects the euro area to expand its GDP by 1.2 per cent in 2014, after shrinking by 0.5 per cent last year. The macro indicators are showing steady improvement in larger economies such as Germany, France and the Netherlands. Leading European companies are also a great play on global recovery with significant earnings coming from exports, leaving room for further upside.

Track record : The Franklin European Growth Fund has an impressive track record. Its five-year return at 23.3 per cent is well ahead of the MSCI Europe’s 17.3 per cent and the three-year gains at 17.1 per cent are well ahead of the index’s 10.1 per cent.

This makes it a good choice among the various European stock funds.

Valuations : Valuations for the European markets (MSCI Europe Index) continue to be at a discount to the US and the rest of the world. Price-earnings for European markets based on one-year forward earnings stood at 13.8 times by end-March with a dividend yield of 3.2 per cent. This compares with 14.8 times (dividend yield 2.4 per cent) for MSCI World and 15.7 times for the US.

The Indian market trades at 14.7 times on a comparable basis.

No dollar diversification : A key motivation for Indian investors to buy global funds is to diversify their currency exposure. The dollar, given its status as the reserve currency of the world, is a much better diversifier on this score than the euro. Should the winding down of US easy money policies or a hike in interest rates prompt a flight of foreign funds, the dollar may appreciate further against the rupee.

Industrial tilt : With financials, industrials and consumer firms dominating, European markets do not offer the diversity that the US market offers to Indian investors.

Indian investors seeking exposure to social media or technology product companies not present in domestic markets may find a wider array of choices in the US.

Modest growth : Europe may be on a turnaround but the growth prospects it offers are quite modest compared with India or other emerging markets. Europe’s expected 1.2 per cent and 1.5 per cent GDP growth rates for 2014 and 2015 are against 5.4 and 6.4 per cent for India.

This may make it easier for Indian companies to deliver a double-digit growth in profits next year than their European peers.

European equity funds may deliver good returns in the next one year or so, given the region’s turnaround story.

But Indian equity funds may prove a better investment, and US equity funds a better diversifier, for the long term.

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