Continental European equity markets were solidly up in Q3 (£ currency) despite the asset class having a number of issues to deal with. Politics and Geo-politics dominated many of the headlines – challenging Brexit negotiations, the introduction of specific trade tariffs and, on the final day of the quarter, Italian budget disappointments.
Despite some headwinds earlier this year the European economy remains in good shape. Inflation continued to move in the right direction, buoyed by signs of wage inflation, and President of the European Central Bank, Mario Draghi, also noting a “relatively vigorous” pick-up in inflation. German bund yields duly recovered. Against this backdrop, oil & gas and healthcare were the standout performers. Industrials were also strong. Financials managed to weather the difficult environment – finishing up for the quarter. Only the telecoms sector was down in absolute terms.
In the three months to the end of September 2018, the fund returned 2.84%, underperforming the fund’s reference benchmark, the FTSE World Europe Ex-UK Index which returned 3.10% (£; total return), but outperforming the fund’s peer group, the IA Europe excluding UK sector, which averaged a return of 1.59%. *
In terms of relative performance there were a number of positives and negatives. The contribution from sector allocation and stock selection were broadly similar. Our overweight, relative to the reference index, in oil & gas helped but was offset by our telecommunications. Our large underweight in consumer goods also provided some attribution.
A number of our holdings did well in the quarter. Within pharmaceuticals Novartis and Sanofi were standout performers. Within consumer services Carrefour was up strongly.
After a difficult Q2 some of our specific industrial stocks did much better – in particular AP Moller-Maersk and Deutsche Post. For Deutsche Post we are positive despite some of the near-term headwinds in the Parcels division. Management have a robust plan in place to deal with these issues, which should become visible over time. For AP Moller-Maersk the short-term environment in container shipping is tough with the industry struggling to pass on higher fuel costs. Beyond these short-term pressures the outlook for demand/supply, is gradually moving in the right direction.
A number of holdings detracted from performance in the period. Of note was marketing and PR company Publicis – a combination of weaker organic growth in Q2. On balance we believe this should be the low point in growth for Publicis with new account wins set to help in the second half of 2018. Ryanair, another weak relative performer, is struggling with a number of shorter-term headwinds – a combination of strike action and higher fuel costs. This, in our opinion, ignores the efficient and flexible business model and best-in-class productivity, which leaves the company well-placed in the medium-term.
The overall shape of the fund remains much the same. Oil & gas, telecoms and financials are still the largest active overweights compared to the reference index. Likewise, consumer goods, technology and healthcare are still the three largest underweights. Three new positions have been initiated – an industrial, a technology company and a materials company. Three holdings were sold – one from technology, one from consumer goods and one insurer. There has been some re-shuffling of positions within sectors but very modest at a fund level.
|Performance (% growth)*
|| Invesco European Equity Fund (UK)
||FTSE World Europe ex- UK index
||IA Europe Ex UK sector
Past performance is not a guide to future returns.
|Standardised rolling 12 month performance (% growth)*
*All data is as at 30 September 2018, sourced from Invesco unless otherwise stated. Fund and sector average performance data is source: Lipper, Fund performance figures are shown in Sterling, inclusive of reinvested income and net of the Ongoing Charge and portfolio transaction costs. The figures do not reflect the entry charge paid by individual investors. Sector average performance is calculated on an equivalent basis. Fund performance figures are based on the Z accumulation share class. Performance figures for all share classes can be found in the relevant Key Investor Information Document. Sector is IA Europe excluding UK peer group. Reference benchmark and other index information is source: Thomson Reuters Datastream, total return, GB£. Reference benchmark is the FTSE World Europe ex- UK index.
Strategy & Outlook
This year it has been easy to get swamped in nasty-looking headlines such as Italian politics, trade wars and immigration. Add to that some softening in European macroeconomic data this year and the market suffered a substantial downturn in early part of the summer, weighing heavily on performance.
What can we expect from the European economy? - Steady if unspectacular growth. The outlook for domestic demand looks good as Europe recovers from the various crises of the last decade. Corporates are regaining their appetite to invest again whilst falling unemployment and rising wages are supporting consumption. Underlying inflation is gradually recovering. Although a lagging indicator, wages are rising and not just in Germany but in the periphery too. To us this appears inconsistent with negative interest rates.
What could go wrong? An escalation of trade wars would almost certainly impact growth but the strength of domestic demand should at least provide some mitigation in a very negative scenario and leave the economy better placed to bounce back afterwards.
And what about Italian politics? Whilst the outcome of budget discussions spooked markets, with the budget deficit higher than expected, much would have to go wrong from here before this becomes another Eurozone crisis. The budget proposal will need to navigate several safeguards built into the constitution before becoming law. President Mattarella is central to this as he is responsible for ensuring any legislation is constitutionally acceptable. No doubt lively negotiations will also be held with Brussels.
Does Italy really want to leave Europe? For one the constitution forbids referendums on international treaties – such as EU membership and the Euro. Putting that to one side, recent polls questions this view - if anything support for the Euro and Europe has gone up since the new government was established. So, the situation is complicated, yes, but not necessarily as negative as it appears. If the outcome isn’t nearly as bad as current valuations suggest (eg for financials in Italy and elsewhere) we believe there is a good opportunity for a relief rally.
It will then come as no surprise that the shape of the portfolio is little changed. The market preference for higher quality companies this year has given us opportunities to add to our existing positions, many of which sit at the ‘value’ end of the spectrum. There are sources of value too in many sectors: we remain convinced of the opportunities we have identified in financials, oil and telecoms, but latterly we have also found very compelling valuations elsewhere, for example in pharmaceuticals on a stock-specific basis. So despite disappointing performance overall this year - although some encouraging signs more recently - there are genuine reasons to be optimistic about our positioning.
The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.
The fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the fund. The Manager, however, will ensure that the use of derivatives within the fund does not materially alter the overall risk profile of the fund.
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