So why don’t Canadians see this remarkable growth when they look at European markets? Kingsford explains that index performance in Europe tends to be far more mixed. Especially compared to the US market where an index like the S&P 500 occupies a huge amount of investors’ attention. Kingsford argues, though, that these smaller names in Europe offer an opportunity for investors to beat indexes, not just mirror them.
Key, also, to understanding European markets is the fact that they are more federated. Novo Nordisk would be listed in Copenhagen, ASML is listed in Amsterdam, Siemens is listed in Frankfurt, and Shell is listed in London. Those are large-cap names, so unearthing small and mid-cap gems requires sifting through a significantly larger array of markets and nations.
Kingsford notes that this has become more challenging for Canadian asset managers after European regulators took steps to unbundle market research from trading commissions for investment banks. As a result many once-great sources of market research have pulled back their research in Europe, to largely focus on large-caps. This has left the mid and small-cap space somewhat uncovered.
So why should asset managers wade into this murkier space? Kingsford notes that in addition to the true alpha opportunities that have emerged from Europe, its smaller-cap names offer some additional benefits. Namely currency exposures. Higwood’s allocations are split, roughly, into one-third Euro, one-third dollars, 20 per cent Sterling, and 10 per cent Scandinavian currencies. This can introduce new currency offsets into a portfolio. Moreover, you can get greater geographic diversification at a smaller-cap level. Where a US company with a $5 billion market cap is likely still a domestic business due to the size of the US economy, Kingsford says that a similar sized company listed on a European exchange likely has business lines extending far beyond its national borders and even the borders of Europe.
The attractiveness of this market segment, Kingsford says, comes most apparent in the context of a US market now trading at significant multiples. With the S&P 500 averaging around 28x earnings, many investors are looking to pick up value. European mid and small-caps, Kingsford says, are trading around 12-13x earnings. European equities as a whole are at around 15x. That value comparison, Kingsford says, makes an almost textbook case of European stocks with a likelihood of stronger returns and a better margin of safety.
