Europe offers a vast and varied landscape and at more than 20 per cent of the world market should naturally for part of a balanced portfolio. But its place in a portfolio need not be a dead weight and with the right manager picking the right stocks, a European equity investment could prove to be profitable through the recovery and be brought in from the cold.

European equities have been left out in the cold. They have underperformed the world market since the equity rally began in March last year and, like most Western markets, have disappointed investors over the past decade by providing a negative return.

So strong is the feeling of investors against European equities, that a survey of fund managers’ asset allocation preferences put the continent’s shares last behind emerging markets, the US, and perennial underperformer, Japan. Europe topped the same poll in 2006. What has caused this turnaround and is it terminal? I do not think so and am optimistic about the asset class during this recovery. 

The western and eastern extremities of the continent seem to be the weakest links and cause those pessimistic investors concern. High personal debt and the hangover of a burst property bubble are taking their toll in the west: in Ireland and Spain. While the continent’s emerging economies to the east have the potential to reverse their recent promise and drag their closest neighbours with them. Close ties between Germany and its emerging neighbours is a particular concern highlighted by the banking crisis.

In spite of these out-lying problems, the region has begun the road to recovery with its core economies emerging from their recessions. But, like the rest of the developed world, growth is likely not to resume the break-neck pace investors have become accustomed to in recent years.

But it’s not all bad news for the region’s investors and there are several very good reasons not to ignore European equities in this recovery phase. Europe’s equities are valued attractively in comparison to other regions so have the potential to outperform. Their poor performance relative to other regions in the world means their price to book ratio trails the BRICs, the US, emerging markets and the UK.

Contrarian investors have a history of beating the market. This, of course, means making an investment when no one else is and it therefore feels most uncomfortable. But here are a few reasons to buck the trend of turning away from European equities.

1, European equities are a good way to access growth in emerging markets while offering the stability, security and liquidity of a developed-world investment. Almost half of Europe’s exports end up in emerging markets and many established companies tap into these markets with operations on the ground.

2, Europe’s changing demographics are usually brought up in the context of a growing imbalance between the dependant ageing population being supported by a shrinking working population. While this trend undoubtedly stresses parts of the economy, some sectors will benefit from this shift. The healthcare and pharmaceutical sectors are the most obvious, but leisure and tourism could also make ground as healthy, wealthy early retirees enjoy their new-found freedom to explore their interests.

3, Yes, many people anticipate economic growth to be slower than the several years before the recession, but this does not mean companies cannot grow their earnings and improve their margins. It is quite reasonable to expect certain companies, those that are not dependent on economic recovery, to prosper in a low-growth environment. European companies involved in fledgling industries such as green energy could prosper in these circumstances. Low interest rates and a relatively low inflation environment should provide the perfect conditions for ambitious companies to forge a path through the recovery period.

4, The financial crisis was a unique event and meant that the recession that followed it was not the same as previous slumps. We think the recovery, therefore, will also follow an unconventional path. Previous downturns have been reversed by the formidable buying power of the US consumer. US consumers still carry a great deal of debt and could therefore be slow to return to their profligate habits. Because companies were quick to react to the recession and took a knife to costs very effectively, they are in a good position to maintain profitability, and therefore capital investment, which in turn should support a recovery. Conservatively managed European companies have retained strong financial positions and are therefore in good shape to capitalise on a corporate-led recovery.

5, And finally, because core European consumer and corporate finances are on a relatively sound footing, having not borrowed and spent to excess, there is a good foundation for the region’s longer-term recovery.

Europe offers a vast and varied landscape and at more than 20 per cent of the world market should naturally form part of a balanced portfolio. But its place in a portfolio need not be a dead weight and with the right manager picking the right stocks, a European equity investment could prove to be profitable through the recovery and be brought in from the cold.