As Europe's actions toward addressing its sovereign debt crisis evolve, so may the investment opportunities within the region. Politicians around Europe seem increasingly aware that austerity alone cannot solve the region's debt crisis and that a healthier level of economic growth is necessary. Any meaningful transition away from harsh austerity measures would, we think, bode well for many of Europe's more domestically-oriented companies. We have begun to find such companies with attractive risk/reward profiles and, from our perspective, the characteristics of these businesses make a European-focused mutual fund an attractive option for an investor to gain exposure to this opportunity.
Comments by a growing number of eurozone leaders, as well as the European Commission's recommendations in May to give some countries more time to complete austerity plans, reflect new flexibility for Europe's politicians. We believe the austerity measures of recent years have been necessary, but the singular focus on reducing government outlays has been at the expense of policies to support an economic recovery to help lower unemployment, boost consumer spending and increase tax revenues. In a region where politicians and policies tend to move slowly, the recent rhetoric and policy moves were generally viewed as a first step toward possible pro-growth measures. We also believe that earlier regulatory reforms, such as those enacted in Italy, Spain and other countries, have helped significantly reduce red tape, which we think should make it easier for companies to do business and potentially offer a tailwind to “pro-growth” investments.
The change of view within Europe may prove to be favorable for the Mutual Series current strategy. Under the strict austerity measures, we had determined the most attractive value opportunities in Europe were among the region's multi-national exporters. These businesses are predominantly based in Northern Europe with significant exposure outside the continent, particularly to North America and Asia. As deep-value investors, we found this cross-section of companies to be particularly compelling since they appeared to us to be unduly penalized by investors for being headquartered in Europe, despite strong growth records and healthy balance sheets. This strategy has largely paid off over the past couple years. From a valuation viewpoint, many of these stocks have since experienced significant re-ratings as other investors have seemingly caught up to our investment views.
We are now beginning to find more attractive risk/reward profiles among companies that generate most of their revenues within Europe. We believe these companies are likely to benefit significantly from any economic improvements across the continent. When compared to other developed markets, Europe looks more attractive to us on a price-to-earnings, a price-to-cash-flow and a
dividend-yield basis. However, among domestically-oriented companies to which we have been paying close attention, valuations, in our view, have been generally more attractive than, or valued in line with, the overall market.
These are the moments when we view active management as having a distinct advantage over more passive methods. The potential opportunities among domestically oriented companies are generally quite diffuse and typically involve companies that are smaller than European multinationals. Indeed, we have been finding what we view as attractive opportunities among mid-capitalization stocks, some of which do not have American Depositary Receipts, making a European-focused mutual fund a potentially efficient way for individuals to invest in these companies. With our valuation discipline, intensive research process and on-the- ground investment professionals, we are able to identify, analyze and invest in these opportunities.
Katrina Dudley is a portfolio manager at Franklin Mutual Advisers.
