IPE Views: Europe expands!
Investing in European equities is much more complex than it may appear at first glance, warns Joseph Mariathasan
When my children were in nursery school, they always used to get confused between Austria and Australia. I had to explain that one was a small country in Europe with lots of mountains and the other a large country on the other side of the world with no mountains. Luckily, they have grown up a bit since then, as I would have a hard time explaining to them why Australia is now an entrant in the Eurovision Song Contest this year (yes, it’s true), hosted, appropriately enough, in Vienna in May. Perhaps Melbourne may have been an alternative option given Australia’s participation, particularly since it is reputed to be the second-largest Greek city after Athens. And if Greece’s largest export continues to be its young people, it may end being the largest!
Investors face the same issue – what exactly does Europe mean? Investing in European equities may seem a straightforward decision, but deciding what constitutes Europe, unlike the US, is not so clear. Football association UEFA includes Kazakhstan, whilst Israel has won the Eurovision Song contest three times and hosted it twice. Neither country, however, would usually be seen as part of a European equity mandate.
The euro-zone may be a clearly defined concept, but it would exclude major investment destinations such as the UK and Switzerland, which would be an odd choice, particularly for non-European investors. But even euro-denominated investors would then face the issue of how best to incorporate exposures to countries with major stock markets such as the UK, Switzerland and Sweden.
What such examples indicate is that making arbitrary groupings of countries based on geographical proximity alone inevitably leads to debate as to what is appropriate. Does it matter? For active mandates with managers that are producing focused portfolios, probably not. But for investors seeking to gain a broad exposure to European equities, deciding what that could mean does have implications on where their exposures will lie.
Whilst much of the variation in economic exposures within any European stock market can be accounted for by stock-specific factors, some can also be attributed to the legacy of history. The UK and the Netherlands, for example, have many international companies built up from the days of their colonial empires that spanned the globe with a high exposure to emerging markets. This has produced some interesting comparisons between British and Dutch companies and their US direct competitors. The US companies have not had to compete overseas quite as much as the Europeans, as they have had a very large domestic market of their own and never had the contacts and distribution network overseas the Europeans gained through their empires. Unilever grew under the Dutch empire, and managers tell me Procter & Gamble could not compete as well as Unilever in Indonesia, for example.
It is not just the UK and Dutch stock markets that have benefited from the days of empire. Austria has a high exposure to countries in Eastern Europe, many of which it had historical ties with from the days of the Austro-Hungarian empire, whilst parts of Southern and Eastern Europe have long-standing religious and cultural ties with Greece dating back to the Byzantine empire. In contrast, Portugal, despite its imperial history, has the highest domestic exposure of any country in Europe, and Spain again has not been able to emulate the UK and the Netherlands in terms of incubating global companies during its colonial past.
Less surprising are the smaller countries such as Switzerland, Finland, Ireland and Sweden, which have some very large international companies domiciled in their jurisdictions, but whose local markets provide an insignificant share of their revenues. Schindler Group in Switzerland and Kone in Finland are two of the four companies dominating global sales in elevators. Needless to say, the home market was not what they built their businesses on.
Investing in European equities is a much more complex idea than it may appear at first glance. Individual countries are too small to be considered as separate investment destinations except by domestic institutions that still cling onto an unjustified home bias. But what constitutes a natural collection of countries to define an investment strategy is not straightforward in a region whose political boundaries have been rearranged countless times and whose companies often reflect empires that once spanned the globe.
The only thing everyone can agree on, apart from perhaps some of the residents of Melbourne, is that Australia is not part of Europe!
Joseph Mariathasan is contributing editor at IPE