European funds

Europe is coming out of the woods & is expected to give good returns, but prospects from US look equally good

This month, three fund houses - Religare Invesco, JP Morgan and Deutsche AMC - launched Europe- focused schemes. Many others are expected to follow suit. Reason: Europes prospects seem to be improving.

Industry experts say Europe is at the point where the US was in 2011 - just about to recover. That makes it an opportune time to invest in the European story. According to a presentation Religare Invesco at the launch of their new fund offer (NFO) for pan- Europe fund, out of the top 11 sectors, all, barring consumer goods, are currently trading at a discount to their long- term average cycle price- to- earning (PE) ratio.

At all three levels - individual level, corporate level and country level - the balance sheets in Europe are healing. These are much better than what they were six months ago. European Central Bank president Mario Draghi has assured all that can be done to protect Eurozone from breaking down will be done. Also, the Europe- focused funds being launched dont have exposure to companies drawing revenues only from Europe, but they also have presence in the US and emerging economies, thus making it safer. At the same time, given that the US Federal Reserve has decided to reduce the pace of monthly asset purchases to $ 65 billion next month, compared to $ 75 billion it purchased in January, shows the economy continues to do well. Hence, investment experts feel sticking to the US is also as important.

If an investor already has an exposure of around 10 per cent to the US markets, we would advise him to stick to it. On the other hand, if he wants to increase the exposure into global funds, then he can look at an additional five per cent allocation to the European markets. Pothen adds that the multi- national companies (MNCs) such as BMW, Siemens, Adidas, Carrefour and other well known large caps from Europe are in good financial health. MNCs have significant exposure to overseas markets such as Asia and EM (emerging markets). A weaker Euro will also help boost exports of the MNCs.

A five- to- 10 per cent exposure in foreign funds should be good, says Hemant Rustagi, CEO of Wiseinvest Advisors. Given the US funds have given 45- 50 per cent last year, you could move your gains made on these funds to Europe, maintaining your exposure to the US, he suggests.

While the overall situation has improved, there is some more pain left in Europe. Sovereign debt woes from weak peripherals continue to lurk in the background, particularly for certain suspect countries where reforms previously pledged have either been delayed or rolled back. Markets continue to demand decisive action from politicians, which is not going to take place overnight.

Historically, European equity has traded at a mean PE of 15.6X. We reduce our previous discount of 20 per cent to the mean PE given the stabilisation seen on the continent and growth expectations. Our estimated fair PE is now 13.5X earnings.

Even at such valuations level, the market has a potential upside of just over 19 per cent based on 2015 estimated earnings (as of September 23, 2013 in local currency terms).

If you are willing to invest in these funds, remember a couple of important things. One, the tenure of investment should not be short- term ( less than a year) because there will be a short- term capital gains tax that will erode the returns substantially.

Since international funds are treated as debt funds, the capital gains will be added to your income and taxed accordingly.

For the highest- income tax bracket, this rate would be 30 per cent. The long- term ( more than a year) capital gains tax is 10 per cent and 20 per cent, with and without inflation indexation benefits, respectively. Also, invest for at least two- tothree years, thereby giving time to the scheme and fund manager to perform.