Bruised and battered, the euro still inspires remarkable optimism among portfolio managers, who like the prospects for both the currency and for European equities. “A year from now people will wake up and realize that the euro had been very undervalued,” says Michael Perelstein, senior investment officer of Schroders Investment Management North America in New York.
A recent survey by Evaluation Associates found that more than 80 percent of fund managers believe that the euro is undervalued, says Bryan Decker, director of international research at the Norwalk, Connecticut-based financial consulting firm. Adds Perelstein, who manages the $100 million-in-assets Schroders International Fund, “European economic growth will exceed American growth” in another 12 months. Perelstein increased the European weighting in his fund from 50 percent last year to 75 percent this year.
In late September just after the euro dropped below $0.85, an all-time low, the Group of Seven, together with the European Central Bank, stepped in to support the currency. Having lost more than a quarter of its value versus the dollar since its January 1, 1999 launch, the euro had failed to respond to six ECB interest rate hikes in the past ten months, totaling 150 basis points.
“The ECB simply does not have the God-like figure of [Federal Reserve Board chairman] Alan Greenspan wielding an iron hand over inflation,” says Ian Hart, portfolio manager of Fidelity’s Europe Capital Appreciation Fund, which has $800 million in assets. “Although everyone is focusing on how weak the euro has been, the fact that it has even survived is hugely important.”
To be sure, the U.S. economy, in its tenth year of expansion, is still barreling along at a much faster clip than its European counterparts. Parker King, senior currency analyst at Putnam Investments, believes that substantial net equity outflows from Europe in the early part of the year have eroded confidence in the euro. “The outflows were tremendous and caused great uncertainty about the currency,” he says.
Despite the currency’s weakness, fund managers are making macro and sector bets on European stocks. Frankfurt-based Klaus Hagedorn, senior portfolio manager of Payden & Rygel’s $75 million-in-assets European Aggressive Growth Fund, is convinced that companies will benefit from the changing demographics of Europe - specifically, the aging of European baby boomers, the men and women born between 1946 and 1964. (His fund has returned 98.92 percent since it was launched in June 1999, compared with just 8.47 percent, in dollar terms, for the MSCI European index.)
Hagedorn and his co-manager, Kevin Hight, focus on financial companies that will manage the retirement funds of aging baby boomers. They especially like Marschollek Laut Und Schlager Partners, the largest independent insurance brokerage in Germany, which has a growing asset management business. (It reports mutual fund assets of more than E1.4 billion.) European Aggressive Growth bought the stock in June 1999 at E39; it currently trades at about E154.
Another favorite is Kamps, a German bakery consolidator, which buys scattered mom-and-pop bakeries and uses them to distribute centrally prepared goods. The company recently expanded into the Netherlands and France. “They have made baking a high-margin business without sacrificing the cultural flavor of a small-time German bakery,” says Hagedorn. He picked up the stock for E15.50 shortly after the fund’s launch; it now trades at E23.75.
The pair scored even more impressive gains with Editoriale L’Espresso, an Italian publishing house that is consolidating its business and spinning off a Web site. They bought the stock at E4.90 in June 1999 and watched it rise to a recent E15.40. Their fund also owns a handful of biotech stocks, including Qiagen, a $750 million-in-revenues Dutch company that provides both technology and products used in DNA and RNA research. Qiagen’s operating income has increased 52 percent annually for the past five years. The fund bought its stake at E8 about 16 months ago, and the stock now trades at about E55.
Fidelity’s Hart shuns European biotech stocks because the sector is so small, representing less than 0.1 percent of the MSCI European index. “It is a bit of a crapshoot to find the right company,” he notes. But Hart is enthusiastic about insurance companies and asset managers, which will benefit from tax reform in Germany and Italy.
Schroders’ Perelstein feels upbeat about the financial sector as well. Last March his fund rotated out of technology, media and telecommunications stocks and into financials, utilities and pharmaceuticals. “Europe is very similar to where the U.S. was in the late 1980s,” he says. “Germany just passed a huge corporate tax cut, and the French and Italians are following suit. There’s a copycat effect going on that is extremely positive.” To capitalize on this, Perelstein is loading up on European banks. He recently bought ING Barings and Deutsche Bank, which he says is “one of the cheapest banks in Europe.” He believes that Deutsche Bank will benefit from German tax reform in that it can now sell many of its industrial assets without paying a huge capital gains tax.
Along with financials, Hart has been buying European media stocks. He likes formerly state-owned companies because he believes they will benefit from the efficiencies associated with privatization.
Energy is a new favorite of Hart, who has been bullish on the sector since the start of the year. These days his fund’s top holding is TotalFinaElf, the Paris-based oil company. “With oil inventory at a historic low and with robust demand across the globe, this should be a good time to invest in the sector,” he says.
His portfolio may be a motley mix, but Hart has a winning hand: His Europe Capital Appreciation fund had annual returns of 16.17 percent for the 12 months ended August 31, 15.77 percent for the past three years and 18.08 percent for the past five years. For the same periods the MSCI Europe index returned 10.03 percent, 15.80 percent and 17.75 percent, respectively.
Stephen Beinhacker, senior vice president and portfolio manager of Alliance Capital Management’s New Europe Fund, with $325 million in assets, is a GARP, or growth at a reasonable price, investor whose bottom-up approach is driven by internal research. He invests primarily in large European companies with market capitalizations of $3 billion or more. His current mix favors information technology hardware, insurance and the media. A couple of favorites are France’s Alcatel and ASM Lithography Holding, a Dutch company that manufactures equipment used to make semiconductors. Says Beinhacker, “Strong technology companies rarely come cheap, and these were priced at a fair value with attractive growth potential.”
In the insurance sector the fund holds such stocks as Italy’s Alleanza Assicurazioni, CGNU in the U.K. and Zurich Allied in Switzerland. Impending tax reform could boost the profits of insurance companies if the changes in the law inspire customers to buy more of their financial products. The Italian government, for instance, hopes to motivate individuals to double their retirement savings by giving them a tax break. “These companies represent a perfect GARP opportunity,” says Beinhacker. “They are experiencing double-digit profit growth, sales remain strong, and the cycle for pricing in the insurance industry globally has turned.” His fund posted total annual returns as of August 31 of 17.66 percent for one year, 16.76 percent for three years and 16.98 percent for five years.
Perelstein is one of many portfolio managers who are bullish on European pharmaceuticals manufacturers. Novartis Pharma, a Swiss company, is his second-largest holding. He also holds Glaxo Wellcome in the U.K. and Sanofi Synthelabo in France. Perelstein likes pharmaceuticals for their predictable, steady earnings and their potential for growth, given Europe’s aging population. His fund posted total annual returns of 18.22 percent for the 12 months ended August 31, 12.75 percent for three years and 11.95 percent for five years.
Will any of this optimism help the beleaguered euro? Eventually, it will, suggests Alliance Capital’s Beinhacker. “There are too many managers who are bullish on the euro, yet the currency is weak,” he says. “Maybe the market needs to capitulate. Maybe we all need to be bearish on the euro for it to go up.”
