Hidden value gems remain in Europe

Turbulence in euro-land is definitely something investors should be concerned about. But instead of panicking, they should remain objective and focus on quality, something they haven’t done for a long time, say those on the ground in the Old World.

“What investors need to do is emphasize quality companies; low quality has really prevailed in the last few years,” says Dublin, Ireland-based David Hogarty, head of strategy development, Kleinwort Benson Investors, sub-advisor for BMO Global Dividend Class. “People have wanted higher risk stocks; they have looked for more volatile leveraged companies that they feel can climb most aggressively on the upside.”

European problems will persist and jittery investors would do well to know equity markets will be bumping along sideways for quite a long time, he says.

“In that environment the trick is not to focus too much on the capital appreciation side, but to try and maximize the income that you get,” says Hogarty.

When equity markets go sideways, income becomes the only source of return. Canadians, he adds, know this well but investors in other parts of the world could use some education.

Contrary to what the current European crisis would suggest, there are many companies in Europe that have very strong balance sheets. Hogarty encourages investors to look at those European companies and the ones that have very low levels of debt and hold plenty of cash.

“Companies which are trying to put their balance sheets to work because ‘retained earnings’ is one of the biggest problems at the moment with listed companies,” says Hogarty. “Those that have made profit are neither paying them out to shareholders as a dividend, nor reinvesting them. They’re just holding them as cash on that balance sheet.”

However, Paul Taylor, chief investment officer, BMO Harris Private Banking, Chicago, is giving Europe a wide berth for now.

“We’re relatively neutral on geographies with one exception and that is we’re generally underweight or avoiding euro-land more broadly from exposures perspective,” he said in a recent conference call.

“Our bigger bet,” he explained, “is not on the broad asset class level or by geographies; it’s more by characteristics and by capitalization. We believe that quality franchises, ones that are going to be here regardless of external environment, should be our focus.”

Taylor also asked investors not to get influenced by growing noises about going 100% cash. “We’d argue one needs to step back and look objectively at what’s happening [within the context of one’s] risk-return profile and make sure their portfolio is pointed in the right direction,” said Taylor. “Reducing risk profile does make sense at this point in time [and that means] somewhat lower equity weight.”

It pays to be opportunistic during volatile times because “whenever there is significant volatility, there’s certainly opportunity in the market place.”

Sherry Cooper, chief economist, BMO Financial Group, asked investors to brace for tough times. “Unfortunately this uncertainty will plague the markets for an extended period of time,” she said on the same call.

Cooper expressed the view that when the dust finally settles the euro as a common currency will remain, but “all the countries in the European Union, however, may not remain.”

While not ruling out that some countries—hello Greece—could exit the union, Cooper said that it “would be so disruptive and so inflationary for Greece that instead other measures will be taken to more forcefully integrate the fiscal policies to create what ultimately will be a federation of European countries, commonly called the United States of Europe.”