Can Next Generation EU turbo-charge European equities?
Can Next Generation EU turbo-charge European equities?
Next Generation EU is the ambitious plan to help European Union member states recover, repair and emerge stronger from the Covid-19 crisis. This is partly thanks to the recently agreed €750 billion European Recovery Fund. Member states will be provided loans and grants in frontloaded financial support for the crucial first years of the recovery.
The plan includes measures to boost private investment and to accelerate the twin green and digital transitions. Member states are encouraged to focus investment and reforms in certain flagship areas: renewables, infrastructure, technology, transportation, agricultural development, connectivity, data and education.
We think Next Generation EU could provide a significant boost to some already fast growing areas of the market in Europe. In doing so, it could help change some outdated preconceptions of the exposures investors gain by investing in European equities.
Europe’s sector mix has changed over the past decade
Europe sometimes suffers from the view that it offers overwhelming exposure to "old economy", structurally challenged sectors. In fact, over the last decade, the make-up of European equities has changed substantially.
The chart below highlights the evolution in sector composition of the flagship MSCI Europe index. Over the last decade, the combined sector weights of energy and financials has fallen from 33% to 20%, with healthcare now the largest sector. Information technology’s weighting has more than doubled.
While the benchmark composition makes little difference for investors focused on stockpicking, it may go some way to changing the perception that Europe lacks innovative, market leading global companies.
Just as the opportunity set for European equity investors has changed considerably over the past decade, so it is likely to change over the next one. Companies that can provide solutions to new challenges are likely to see faster growth.
Key among these challenges are ageing populations, the digital transition, climate change and, not least, the current pandemic. We think the EU’s response – Next Generation EU – could help promote a sustainable recovery and support the innovative businesses of the future.
As well as the EU spending, individual countries have also announced extra spending; for example, France has announced €30 billion is to be focused on green initiatives and technology. Such unprecedented levels of investment is an important collective breakthrough for a region aspiring to higher productivity and sustainable growth.
Which investment areas could see benefits?
The Covid-19 crisis has accelerated a number of trends that were already in place, according to Schroders' experts. Among these is rising healthcare spending, which Chief Economist Keith Wade identified as an “inescapable truth” that will shape the investment landscape for many years to come.
Within European equities, Schroders fund manager Paul Griffin has long favoured a diverse range of healthcare companies and continues to see superior growth prospects relative to other sectors: “Even once the worst of the current crisis has passed, we think demand for healthcare solutions is likely to remain robust.
“The pandemic has focused attention on the importance of being prepared. As such, companies producing life-saving equipment and drugs may continue to see elevated demand relative to the pre-crisis period. In addition to large drug manufacturers, Europe is also home to market leading suppliers within the healthcare industry. One such example is Swiss listed company Lonza; a key partner to large pharma groups and small biotech companies”.
Rising carbon awareness and stringent EU emissions regulation is powering a green energy surge. Schroders fund manager Nicholette MacDonald-Brown expects this trend to spread globally with Europe leading by example.
She says “Europe is home to a range of market leading companies whose core business is addressing environmental and social challenges.
“For example, the growth in electric vehicles is fuelling demand for new types of semiconductor materials such as silicon carbide. One of the reasons why market leader Tesla’s electric vehicles are more efficient than competitors is due to the use of silicon carbide chips supplied by a European company: STMicroelectronics. Technology such as this can only aid Europe’s aim of achieving net-zero emissions by 2050 if not sooner.
“Meanwhile, Nordic states and companies have long led the way when it comes to developing unique green technology. For example, Finland’s Neste Corporation has a strong line-up of renewable energy products, including alternative biofuels. Advanced biofuels have a key role to play in industries that cannot be easily electrified.”
Accelerated technological change is another inescapable truth identified by our economics team. Schroders fund manager Leon Howard-Spink highlights that Europe has long been home to innovative and sustainable companies with strong growth prospects in the field of technology.
He says, “Europe offers a deep pool of companies exposed to, and often leading the way in, technological innovation. There are very few industries and businesses out there that are not impacted by digitisation, communication, electrification, the gathering and processing of data, and the increasing development of software and algorithms.
“These advances must be harnessed by all companies to one degree or another to drive productivity and product relevance. As investors looking for growing businesses, we are by necessity driven towards the companies that are benefiting from these trends.”
What could be the impact on profits and valuations?
The changing sector mix in European equities offers fresh hope that the continent could see better earnings momentum. This is because faster-growing healthcare, technology and consumer-based sectors now make up some of the largest MSCI Europe index constituents.
Schroders fund manager Martin Skanberg says ”There is a lot of uncertainty globally at present but I’m bullish that European exposures will continue to shift towards sectors which have sustainable growth prospects above and beyond what we anticipate to be tepid GDP growth globally.
“We’re not naïve about the regular flow of challenges that the region faces. These challenges are reflected in lower valuations relative to other regions. However, the changing shift in Europe, from old economy exposure to structurally growing industries, could lead to a higher, less volatile earnings growth rate. In turn, this could bring a higher valuation, although this will take time.”
What are the risks associated with investing?
All investing comes with risk, its important to understand your investment goals and objectives as well as your risk appetite. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions.
Any references to companies is for illustrative purposes only and not a recommendation to buy and/or sell.
The article is not intended to provide, and should not be relied on for investment advice.
Information and opinions contained herein are subject to change.
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This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
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All data contained within this document is sourced from Cazenove Capital unless otherwise stated.