With the disappearance of currency risk among the 11 countries of euroland, European benchmarks will gain importance in comparison to popular national indices such as the Cac-40, Dax-30 and Aex. Investors will seek to benefit by creating European portfolios that are more efficient and more diversified from a sector point of view. A crucial decision is the choice of the benchmark.
At the moment there are about 11 equity indices available for Europe and euroland. These can be classified as narrow (for example, large cap) versus broad and euroland versus Europe. Twenty-seven large European companies - the so-called 'Magic 27' - are represented in every index. Depending on the benchmark, these stocks together account for 35-40% of total euroland market capitalisation. Sector diversifica tion within the 27 is unfavourable. Many of these stocks are cyclical, while growth sectors are not represented. The Magic 27 do not therefore suffice to create a suitable benchmark. The battle for the leading index is now in full swing. We favour a broad European index as discussed below.
Narrow indices are popular with retail investors. They are relatively easy to track and index derivatives are readily available. For institutional investors able to use tailor-made over-the-counter derivatives the latter argument is less relevant. More important for the institutional investor is that a broad index includes many more stocks in each sector. Broad indices are therefore more balanced from a sector point of view.
The UK, having a weighting of 30% in Europe, Switzerland with 11% and - of lesser importance - Sweden and Denmark are not part of euroland. In the long term it is likely that the UK, Sweden, Denmark and possibly even Switzerland will participate in the euro. This means there is a strong case to include these four countries in an index now. If one or more join euroland, the benchmark will not need to be adapted again. Finally, from a sector point of view a euroland index is less optimal than a European index. The pharmaceutical sector in particular is dominated by large British, Swiss and Swedish companies such as Glaxo Wellcome, Novartis, Roche and Zeneca. Similarly, in the food and beverages sector large companies like BAT, Diageo and Nestlé can hardly be missed. For an investor in euroland a European benchmark has currency risk. This can be eliminated by hedging the currency exposure against the euro. The benchmark can be adjusted accordingly. We therefore prefer a broad European index, such as the MSCI Europe.
At the moment we prefer an overweight position in food and beverages, life insurance, healthcare and services. We like Unilever for its long-term growth prospects. In life insurance we see sustainable growth, because pension and investment products are becoming increasingly popular. In healthcare our most important portfolio holdings are Novartis, Glaxo and Roche. In this sector, positions are concentrated in the larger companies as these have the financial strength to support the necessary research and development. In the services sector the portfolio is overweighted in sectors like software, publishing, (specialty) retail and other services companies like Compass, Hays and Rentokil. The geographical split of the portfolio is close to the benchmark, with a slight preference for continental Europe versus the UK. Within Europe we have overweight positions in Switzerland, France and Spain.
Léon Cornelissen is a senior strategist, Ronald Doeswijk and Hemmo Hemmes are strategists and Mark Glazener is a senior portfolio manager at Robeco Institutional Asset Management