DISTRACTED by the nerve-racking turbulence in Asia and record-breaking markets in the United States, many investors haven't paid a lot of attention to Europe during the past year.
But while investors may have been looking the other way, these markets gained an impressive 28 per cent during 1997, as measured by the Morgan Stanley Capital International Europe index
Europe's lure is that it offers opportunities for growth in developed countries that are poised to tear down the stifling trade barriers that have divided them for so long, industry players say. Next Jan. 1, these countries are set to adopt a common currency -- the European Monetary Unit, or EMU -- and merge into one large, affluent trading bloc.
Britain has so far opted out of the Euro, or common currency, but economic growth there is steady and stock valuations relatively low. Thus many managers are maintaining a substantial weighting there, often about one-third of their portfolios.
Another plus is that both Britain and continental Europe are pretty well insulated from Asia's economic problems, since less than 10 per cent of their exports are sold there. They should therefore be a relatively safe haven if any futher turmoil erupts in the Far East, industry players point out.
So how can investors profit? The conservative might want to consider the $1.55-billion Fidelity European Growth Fund, which boasts a strong and consistent long-term performance record.
It gained a whopping 35.4 per cent in the 12 months ended Jan. 31, helping to give it the highest five-year return -- a compound average annual 21.9 per cent -- in its category.
Lead manager Sally Walden says a rash of corporate mergers, as well as a new thrust by European companies to focus on profits and prepare themselves for an increasingly competitive environment, have fuelled the surge in equity markets.
Mergers and acquisitions will continue to drive these markets forward in 1998, she predicts, because firms are bent on growing much larger so that they can survive and emerge as powerful players in the new European union.
"Europe has always been fragmented -- every country had its 10 banks and its 10 insurance companies -- but now the whole continent is becoming one market, with one currency and that's both a threat and an opportunity for these companies," says London-based Ms. Walden, a portfolio manager with Fidelity Management & Research Co. of Boston.
"After economic union, it'll be meaningless to say you have the biggest bank in France or in Germany."
And the cozy regulatory environment that has sheltered companies in the past is being swept away, she adds. "Europe has always been over-regulated and there's been no motivation to be profitable or to compete. But this new environment will give a shot in the arm to low-cost, innovative companies."
Ms. Walden says that about 55 per cent of her portfolio is invested in banking, insurance, pharmaceutical and telecommunications. The rest is scattered across a wide array of industries, including merchandising, consumer durables and automobiles.
"We see more consolidation and mergers ahead in banking and pharmaceutical companies. In the telecom stocks, we favour the new entrants, the mobile telephone providers," she says.
Substantial holdings include Novartis AG, a pharamaceutical firm based in Switzerland, Deutsche Telekom AG, a telecommunications company based in Germany, and HSBC Holdings PLC, a British bank.
Geographically, the fund holds 33 per cent of its assets in Britain and approximately 45 per cent that is divided about equally among Sweden, France, Switzerland, Germany and the Netherlands. Another 16 per cent is invested in other European countries and there's 6 per cent in cash.
Ms. Walden has no holdings in the emerging Eastern European countries.
"First, it's hard to get the level of financial information I want there and, second, it's not possible to buy or sell large amounts in these countries because their markets are still so small," she explains.
But she sees growth potential there and taps into it by buying Western European companies that sell extensively to Eastern Europe. "But we don't make country bets, we're country-neutral: as bottom-up investors, we focus on individual companies and the location is secondary," she adds.
Another fund to look at is the $124-million AGF European Growth. Manager John Arnold generally favours medium- and small-cap stocks, but he knows that large-caps are the market's darlings right now -- and his fund's sizzling 36.2-per-cent return in the last year came largely from its hefty 40-per-cent weighting in large-cap companies.
"I prefer medium-sized companies because, at the end of the day, the large-caps' potential comes from rationalizing -- usually from sacking a lot of people and not from real growth," he says.
"In spite of my bias, I added larger companies to the fund this year because it's been a big-cap year and I never argue with the market," adds Mr. Arnold, whose fund has a two-year average annual compound gain of 22.8 per cent, a three-year return of 20.8 per cent.
Falling interest rates and a raft of mergers and acquisitions have pushed stock prices up and new money has also been flowing in from European investors, says Mr. Arnold, a managing director of Dublin-based AGF International Advisors Co. Ltd.
Europeans have always received generous government retirement pensions, but it's dawning on those under 50 that the well has run dry, he says. "It's been one of the greatest, best-kept secrets -- no politician wants to say that in 20 years there won't be enough workers to support those who've retired."
Thus, the personal pension market will be one of the fastest growing over the next few years, he believes. About 31 per cent of his fund is invested in banks and insurance companies that are involved in the burgeoning private pension business and there are also large stakes in food retailers, liquor companies and in real estate.
Major holdings include Allied Domecq PLC, a British-based liquor distiller; Iceland Group PLC, a British-based food retailer; a French-based insurance company; and Argentaria-Corporacion Bancaria de Espana SA, a Spanish-based bank.
About 34 per cent of the fund is invested in Britain, with another 16 per cent in closed-end, one-country funds that are denominated in British pounds and invested in various European countries.
Mr. Arnold, who also keeps to Western Europe, has about 19 per cent of the fund in France, 11 per cent each in Spain and Italy, 9 per cent in Germany and the rest scattered across Europe, from Scandanavia to Portugal.
Another manager who sees a dramatically changing scene in Europe is Richard Jenkins, who runs the recently launched Trimark Europlus Fund. Eastern European markets are opening up, old-line Western European companies are evolving into aggressive competitors and European investors, who formerly shunned equities, are pouring into the market, he says.
The geographical scope of this fund is wider than those of most European funds. It focuses on continental European equities but also invests in Britain and has the mandate to add stocks from Eastern Europe, Russia, the Middle East and Africa as these markets mature, explains Mr. Jenkins, vice-president of international equities at Toronto-based Trimark Investment Management Inc. and a member of the investment team managing the $2.9-billion Trimark Fund and the $5.6-billion Select Growth Fund.
So far about 60 per cent of the $25-million Europlus fund's assets are invested, about 85 per cent in Western Europe and the rest in Britain. "Sure, we'll have good companies in the U.K., but initially our emphasis will be on continental Europe, because that's where we see the greatest opportunity," he says.
He's optimistic about the region for two reasons, he says. "First, the opening up of Eastern Europe gives companies in Western Europe bigger markets and lower-cost labour and materials. Second, a new equity culture is developing -- businesses are beginning to use stock markets to raise capital and individuals are finally starting to invest in equities."
The fund will invest in both small- and large-cap companies and will focus on individual firms, rather than allocating assets by country or industry, Mr. Jenkins says. He currently holds 10 companies and anticipates this will rise to 15 or 20 when the fund is fully invested.
Major holdings include the German-based company, Hornback, a leading home-improvement do-it-yourself retailer, and Independent Newspapers, the dominant newspaper company in the Irish Republic.