Europeans are craving U.S. stocks

European institutional investors are beginning to put more faith in the U.S. to lift their equity portfolios.

In a move that goes hand in hand with the trend to invest globally over a strong domestic or regional bias, European pension funds and their equity managers are ratcheting up exposure to the U.S., according to consultants, managers and pension fund officials. And uncertainty surrounding the euro and its impact on eurozone economies is pushing investors faster into the arms of Uncle Sam.

“It’s the first time in a long time that we’re seeing (institutional investors in) Europe moving into U.S. equities,” said Martin Gilbert, Aberdeen, Scotland-based CEO of Aberdeen Asset Management PLC. “Obviously, what they like is the dollar. The dollar is perceived to be strengthening.”

European pension funds historically have underweighted U.S. stocks significantly vs. global benchmarks such as the Morgan Stanley Capital International World index, in which U.S. companies make up about 50% of the total market capitalization of developed countries. Although specific figures for the average European pension fund exposure to U.S. equity were not available, managers and consultants estimated the range at 15% to 35%.

Debbie Clarke, principal and global head of the equity research boutique at Mercer LLC based in London, said that during the past six to 12 months, she has noticed a clear shift in sentiment toward U.S. companies, particularly those with global reach. Consultants and managers said pension funds are mostly boosting their U.S. equity allocation through global strategies. Others are implementing new stand-alone U.S. equity mandates, while some are adding exposure through exchange-traded funds or synthetic overlays without significantly changing the underlying portfolios.

“This is a region where many have been persistently underweight for several years,” Ms. Clarke said. “Valuations, particularly (for) large-cap U.S. stocks, are looking more attractive. In addition, investors have been nervous about Europe. The euro has been under severe pressure, and there are questions as to how (European) companies will cope with that.”

In the five months ended May 31, the euro fell 14.6% against the dollar to trade at $1.23 from $1.44.

Diversification is another attraction. “Clients are adding U.S. equities not only as a way of diversifying out of the region, but also as a way to gain sector diversification,” said Kevin Ng, executive director and client portfolio manager in the fundamental equity team at Goldman Sachs Asset Management in London.

For example, the financial sector represents the largest portion of Europe’s market capitalization, or about 25%. Meanwhile, technology comprises a very small portion. In the U.S., however, technology is one of the largest sectors, with many companies considered to be “global in nature so they are a good source of growth,” Mr. Ng said. GSAM had $840 billion in assets under management as of March 31.

However, Ms. Clarke added, “There are still significant risks (to increasing U.S. equities) related to unemployment and consumer spending, as well as (U.S.) government policies — for example, when will (the Federal Reserve) raise interest rates?”

Concern over U.S. deficit
The “enormous budget deficit” in the U.S. is also a concern, said Richard Urwin, managing director and head of investments in the fiduciary mandate investment team at BlackRock Inc. in London. While the strength of the dollar might help boost U.S. equity returns for unhedged European investors, it also could potentially hurt growth in the longer term, Mr. Urwin said.

“The continued strength of the dollar cuts both ways,” Mr. Urwin said. “A stronger dollar could result in competitive deterioration for U.S.-domiciled companies overseas.”

Nevertheless, the U.S. equity weighting within global equity strategies at BlackRock has generally risen in the past three to six months “for two reasons — the first is that there are clear problems in Europe,” Mr. Urwin added. “The second is that in the second half of last year, we saw a more robust recovery in the U.S., which is experiencing different cyclical strength compared to Europe and Japan.” BlackRock had $3.36 trillion in assets under management worldwide as of March 31.

While large-cap multinational stocks with global reach are favored, managers also are seeing increasing interest in small-cap and midcap U.S. equity strategies, said Jonathan Armitage, head of large-cap U.S. equity and global equity fund manager at Schroder Investment Management Ltd., London. The firm, which has £167.9 billion ($247 billion) in total assets under management, recently introduced an all-cap U.S. equity strategy in Europe to meet increasing demand.

The U.S. equity position within Schroder Investment’s global strategies also has increased; for example, in the global diversified portfolio, U.S. equities comprised 46.7% as of May 31, compared with 36.7% a year ago.

Managers said it’s too early to tell whether the uptake in U.S. equities by European and potentially Asian investors will help to fill the gap left by U.S. investors exiting long-only domestic equity strategies. In addition, they said the preferred route for many overseas investors to gain exposure to the U.S. has been through a global strategy rather than U.S. long-only portfolios.

“Right now, very few global investors hold the full (market) weight to the U.S.” within their equity portfolios, Paul Atkinson, director and head of U.S. equities at Aberdeen Asset, based in Philadelphia. “So the potential is there” for overseas investors to take up some of the slack left by U.S. domestic investors.

Go with best stocks
At RCM Capital Management LLC, an active equity subsidiary of Allianz Global Investors, portfolio managers had a 0.8% overweight position in U.S. equity within the global equity portfolio as of May 31, compared with 5.3% underweight a year ago and 13.5% underweight three years ago, according to Roger P. Miners, managing director and head of business development and client service based in London.

“We believe you should be buying the best stocks in the world no matter where they’re listed,” said Mr. Miners, whose firm has $146.6 billion in total assets under management. “U.S. companies look very attractive right now. Within our global strategy, which is a bottom-up strategy, we’ve gone from a significant underweight position to a neutral and slightly overweight position on U.S. equities.”

A steady move by pension funds divesting from the U.K. to overseas has benefited emerging markets and U.S. equities, said Mike Taylor, CEO of the £3.8 billion London Pensions Fund Authority.

The LPFA’s own strategic shift from a regional approach has been gradual over the past several years. The fund’s equity portfolio is now managed globally, with Newton Investment Management Ltd. and MFS Investment Management as active managers running £430 million and £540 million, respectively. Legal & General Investment Management manages a passive £540 million global equity portfolio, and a separate £110 million synthetic equity portfolio is managed by Insight Investment Management (Global) Ltd.

MFS has been gradually increasing U.S. equity exposure to 44.4% of the global equity portfolio as of May 31 compared with 34.4% two years ago.

“Europe scares people at the moment,” said Peter Preisler, director and head of Europe, Middle East and Africa at T. Rowe Price Group Inc., based in London. “Valuations are really cheap in Europe, and therefore, tempting. But people feel it’s cheap for a reason, and the full consequences of the meltdown in Greece and its effects on the rest of Europe are still not clear.”

“At the same time, we have seen Asia, if not pausing, then slowing down a little bit,” said Mr. Preisler, whose firm has $419 billion in assets under management. “Investors are taking money off the table in Europe, and they can’t keep pouring it into Asia or emerging markets. Therefore, they’re putting more confidence in the U.S. economy.”

Within T. Rowe Price’s own global equity strategies, the U.S. has gone from an underweight to neutral position through a bottom-up stock selection process. “Our global portfolio managers have found good ideas in the U.S.,” Mr. Preisler said.

But it will not be a case of a rising tide lifting all boats in the U.S.

“Stock selection will be a premium because the business environment is going to be that much tougher,” Mr. Atkinson of Aberdeen said.

Assets in Aberdeen’s active U.S. equity pooled fund for institutional and retail investors more than tripled to about $300 million as of May 31 vs. $80 million as of Dec. 31, 2008. Earlier this year, Aberdeen also won two new segregated European institutional mandates totaling $500 million to actively invest in U.S. equities. Overall, Aberdeen manages £170.9 billion globally.

Widespread benefits
While global managers with strong U.S. capabilities are gaining new asset inflows because of a renewed confidence in U.S. markets, some U.S.-based specialist independent managers are also benefiting.

“We’ve been trying to build in Europe probably in the last four to five years. We’ve spent most of that time trying to explain (to institutions) why anyone should be investing in U.S.,” said Paul Chew, partner and head of investment strategies at Brown Advisory, Baltimore. “With the dollar being so weak over the past several years, U.S. equity has looked particularly unattractive.”

But in meetings earlier this year, the tide was changing. “It’s the first time in five years that we did not have to make the case for the U.S. to European investors,” said Mr. Chew, whose firm manages about $18 billion in concentrated U.S. equity strategies. The firm won two new segregated mandates from European institutions this year, one of which totaled more than $100 million. Mr. Chew declined to provide further details.