Time might be right for European funds


January 30, 1994|By WERNER RENBERG | WERNER RENBERG,1994 Werner Renberg

Is it time to consider investing in a European equity fund, if you haven't already done so?

You may be asking yourself this question for one of two reasons:

1. Being comfortable with the level of your investment in U.S. equity funds, you bought an international fund to diversify your portfolio and enjoyed its strong performance in 1993. You now wish to enhance your portfolio's return by adding a fund that's concentrated in one region of the globe. Believing that the hot pace of Asia/Pacific region stock markets may slow down -- and being unsure about Japan -- you turn to Europe.

2. You feel that you are adequately invested in the United States and want to begin investing abroad because you recognize the desirability of such diversification -- especially with U.S. stock prices so high. But you prefer to start by buying a regional fund.

Whatever your situation, the case for buying a European fund -- provided you can accept the risks -- is fairly straightforward. Whether it will turn out to be a good move remains to be seen.

The reasoning goes along these lines:

* In the topsy-turvy world of stocks, purchases made during the gloom of a recession can be highly profitable as stock prices, which reflect profit expectations, are bid up by investors beginning to perceive the improved earnings that should accompany a recovery.

Thus, the sequence of stock prices leading business conditions higher, which has characterized our market since the trough of the 1990-91 recession, should also unfold in Europe, where the major economies have recently been in recession -- except for Great Britain, which seems to be well into the recovery phase.

* In contrast with the situation in the United States, where further drops in interest rates are regarded as unlikely, rates in certain European markets could slip further, thereby aiding interest-sensitive stocks.

* As in the United States, European companies have undertaken programs to cut costs and restructure to strengthen their profitability, thereby giving stocks additional thrust.

These trends are not new to 1994. They emerged in 1993 and helped the major European stock markets, as measured by Morgan Stanley Capital International's Europe 14 Index, to achieve an average total return of 37.7 percent in local currencies for the year.

Translated into U.S. dollars, the return was still a solid 29.8 percent. If a bit behind MSCI's Europe, Australia and Far East (EAFE) Index, which reached 32.9 percent, it was much higher than the U.S. market's 10.1 percent, as measured by Standard & Poor's 500 Index.

Even if the odds are against a similar showing this year, money managers expect European markets to do very well, although some believe the dollar could become stronger against European currencies, again offsetting some of the market's gains. To cope with this, they continue to engage in currency hedging.

Which funds have performed well enough to warrant your study?

* No-load funds such as the 59 Wall Street European Equity Fund (which has a $25,000 minimum initial investment for most investors), Vanguard's European Portfolio, which is managed to track the MSCI Europe 14 Index (and charges a 1 percent transaction fee, payable directly to the fund, on purchases), and the funds of T. Rowe Price and INVESCO.

* The load funds of Putnam, Dean Witter, Merrill Lynch, Alliance and Fidelity.

They differ not only in how they allocate money among countries -- Britain, Germany, and France have the largest markets, accounting for 37.5, 13.9, and 13.5 percent, respectively, of the weights in the MSCI Europe 14 Index -- but also in their stock selection strategies.

Henry Frantzen, who runs Brown Brothers Harriman's 59 Wall Street entry, credits his fund's performance in part to "taking advantage" of falling interest rates, to investing in cyclical companies and to currency hedging in anticipation of a stronger dollar. He began hedging in September 1992, when $1 bought 1.42 Deutschemarks; it now buys around 1.75.

Alan J. Albert, who managed Merrill Lynch EuroFund from its inception seven years ago until his promotion to a senior management position last November 1, attributes his fund's record partly to intensive analysis of companies' financial statements.

Because accounting practices differ among European countries, he said, this work was necessary to determine whether companies' reported earnings had been overstated or understated according to a uniform standard -- and to judge whether stocks were trading at excessive or bargain prices.

His successor, Adrian Holmes, who has worked on the fund since inception, says he believes stock selection will be more important in 1994 than it was in 1993, when the worst-performing major European market, France, had a 21.6 percent return, and Finland led with 83.2.

Justin M. Scott, who manages Putnam Europe Growth Fund, says he looks for companies that not only have improving profits because of economic recovery, cost reduction, and restructuring but also have kept up the quality of their plants and equipment by maintaining capital expenditures during the recession.

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