Niall Gallagher, European equity fund manager at GAM, says the market he invests in will always be more vulnerable to the performance of the global economic cycle than other markets.
He says this is because of the historic make-up of the market, with companies involved in sectors such as energy, car-making, and industrial companies.
But Mr Gallagher says the market has evolved in recent years, and is now more internationally-focused, with companies earning a greater proportion of their revenue from outside Europe.
Focusing on companies with significant international earnings is one of the ways Mr Gallagher believes he can add defensive exposure to his funds.
He says: “If a company is relying on growing its earnings from within the European economy and doesn’t have international earnings, then that is a problem.”
Traditional defensives
Ben Richie, head of European equities at Aberdeen Standard Investments, says while eurozone-listed companies generate revenue from across the world, negative sentiment towards European equities tends to be correlated with the performance of the wider economy, with outflows from European equity funds tending to be larger in the immediate aftermath of negative economic data.
He says that in addition to the traditional defensive equities in the consumer area, there are also financial companies, which are defensive as they benefit from higher volumes of trading of investments when markets are volatile.
Key Points
- European markets will always be more vulnerable to the performance of the global economic cycle
- Some financial stocks count as defensive
- Some consumer staple stocks are affected more by bond yields than economic growth
James Sym, European equities fund manager at River and Mercantile, says that in the event of a significant downturn in the eurozone or global economy, “the stock that the market traditionally views as defensive will once again be viewed as defensive. Some of those stocks might actually look quite expensive now, but they wouldn’t look so expensive if there is a downturn”.
He cites pharmaceutical stocks and consumer staples companies as examples of traditional defensives. But while he is optimistic about the prospects for such businesses in the event of a downturn, Mr Sym is reluctant to invest in most of those businesses at this time.
He says at current valuation levels, with the possibility that a downturn does not occur, investing in some of the lavishly-priced consumer staple companies would offer such meagre returns relative to the risks involved as to be akin to “trying to pick pennies up from in front of a steamroller”.
Many consumer staple stocks – companies that include Unilever and Nestle – have performed strongly over the past decade, almost regardless of the growth rate of the wider economy, due to bond yields being very low.
Low bond yields benefit these companies, which have an income that is low compared with that offered by some other equities, but is higher than offered by bonds, and viewed as equally as secure as the income from a bond.
