European funds offer contrarian appeal

These are certainly troubled times for Europe.

Politicians are not only battling to solve the worsening sovereign debt crisis and prevent a break-up of the eurozone, they are also searching for ways to create both growth and new jobs over the coming months in order to ensure the region keeps pace with the rest of the world.

The 27 EU leaders were even attending urgent talks in early December to discuss how to avoid the financial malaise degenerating into a full-blown recession, and whether tough new fiscal rules should be introduced for the eurozone to stop similar problems happening again.

These economic problems have monopolised the thoughts of just about everyone involved in the investment industry, according to William Sels, UK head of investment strategy at HSBC Private Bank.

"The sovereign debt crisis in Europe has become almost the sole focus for investors of late," he says. "Corporate news flow and economic updates from Asia and the US have largely been disregarded as investors focus on political efforts to save the single currency."

It has also affected the IMA Europe excluding UK sector. The average fund has lost 10.1% over the past year, according to Morningstar figures to 14 November 2011. Even the best performers are in negative territory; the worst are down more than 20%.

Investors have shown their dissatisfaction by voting with their feet. The sector was the worst net retail seller during 2008 and 2009, and it was bottom for the second and third quarters of this year as well. Unless good news emerges over coming weeks, it's hard to see that trend changing.

Just £26.5 billion is invested in the sector, according to Investment Management Association figures for September 2011 - £4.8 billion lower than at the same time last year.

Perhaps more worryingly, the sector accounts for just 4.4% of total assets under management, compared with 8.4% five years ago.

Darius McDermott, managing director at Chelsea Financial Services, says anyone involved in this area is a contrarian investor (one who goes against the tide and disagrees with most other investors) - or, at the very least, an extremely brave and patient one with enough money to risk an area that's fraught with problems.

He says: "It's very difficult to say why anyone should be investing in Europe when its economies and politics are causing so many global problems and potentially sending Western economies into recession. However, European equities are very cheap because of these problems, and if these economies recover those investing in them stand to make decent returns."

There is certainly plenty of negative sentiment on Europe, agrees Patrick Connolly, spokesperson for AWD Chase de Vere, but just because some economies are struggling it doesn't mean that all European stocks are.

"Some excellent companies are generating profits, have high levels of cash on their balance sheets and earn a significant amount of their revenue from outside the eurozone," he says. "Many of them are now sitting on very attractive valuations."

Generally, Europe's economic problems have a big impact on the smaller and medium-sized companies that generate a sizeable proportion of their revenues from domestic markets. This is why a number of managers in the sector are focusing on stocks that earn most of their profits outside the region.

Some parts of Europe are not doing badly. The economies of Germany, Switzerland and France have been holding up well, and domestically-focused firms in these regions still have scope to perform well. These areas are particularly well represented in funds such as BlackRock European Dynamic, which has been the best performer in the sector over the past three years, notching up a 34.36% return - compared with a sector average of -3.29%, according to Morningstar.

The £872.2 million fund, managed by Alister Hibbert, has a number of global giants among its 10 largest holdings, including Ryanair (RYA), Imperial Tobacco (IMT) and Nestlé. In recent months, it has benefited from being overweight in consumer names and underweight in financials and basic materials.

Investors drawn to Europe will need to take a pragmatic, strategic approach to the way they manage their exposures, according to a Fidelity Worldwide Investment spokesperson, who says: "Recessionary concerns may affect the performance of cyclical stocks more than defensive stocks, so it makes sense for investors to take a more defensive stance during these uncertain times."

The uncertain outlook for Europe means it is important to stick with experienced investment managers who have proven track records. Investors should think carefully before taking the plunge, as timing could be everything, warns Andrew Merricks, head of investments at Skerritt Consultants, who argues there is a higher probability of the market falling than rising over the coming months. "You'd need to be Derren Brown to get a positive return this year out of something that is so broken," he says.

"The tide is going out in Europe at the moment and there's no point in trying to do anything other than avoid it or be patient if you have to be in it for any reason."

However, at the end of the day, it will come down to personal choice. "You need to weigh up the probabilities and decide what risk you're prepared to take," he says. "I'd rather be late in and miss the first 5% of a 20% rally than be brave, call it early and end up getting clobbered by a 20% fall."

Quick guide: Is this sector right for me?

Consider investing in this sector if...

• You are a contrarian investor
• You believe European equities will bounce back strongly
• You can afford to lose some of your capital

Fund to watch: Jupiter European

Jupiter's European fund is run by the highly experienced Alexander Darwall. It has the stated objective of achieving long-term capital growth and has been one of the most consistent performers in the competitive IMA Europe excluding UK sector in recent years.

Over the past 10 years, it has returned an impressive 144.98%, according to figures compiled by Morningstar to 14 November 2011. This is considerably more than the 56.06% sector average and enough to put it in second place among more than 60 rival funds.

The fund has 41 holdings, including shares in many prominent companies in Europe, including media group Reed Elsevier (REL), mail equipment supplier Neopost and healthcare provider Novo Nordisk, specialising in diabetes treatment.

In the fund's most recently published factsheet, Darwall insists he continues to see compelling investment opportunities in the region. He says: "We seek out special companies with superior, differentiated products or services, companies that enjoy a structural advantage and the reasonable prospect of long-term growth."

Mark Dampier, head of investment at Hargreaves Lansdown, highlights Darwall's ability to find businesses that are able to grow their earnings despite the challenges in Europe.

He says: "He favours companies operating in niche areas, such as diabetes care and crop protection, that can grow regardless of the state of the overall economy. These holdings have been positive for the fund over the longer term."

Faith Glasgow asks a panel of experts to pick a selection of investment vehicles in: How to grow your wealth: Investment funds and Investment funds for income seekers.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.