Forget Asia – the bargains are in Europe

The booming emerging economies of greater Asia have been a powerful investment theme for several years now, and China has represented the biggest lure of all

Indeed, as the growth of that nation’s domestic industry and infrastructure has accelerated and its consumer class has started to flex newly found muscle, it has overtaken Japan as the world’s second-largest economy, with $5.88 trillion in gross domestic product last year.

Last year, local Asia long-term funds attracted $55 billion in net inflows, according to research firm Strategic Insight. In December, HSBC Wealth Management reported that 75% of fund managers polled were overweight on Asia-Pacific ex Japan equities, up from 44% in the third quarter, and 67% were overweight on Greater China equities, up from 50%.

The stunning growth of China and Asia are a powerful attraction.

But for investors concerned about careful generation of long-term value, this growth could also be a trap. In fact, our contrarian view is that today’s most compelling investment opportunities are to be found not in Asia but in Europe.

TAKE ANOTHER LOOK

Even before the credit crisis shook several European economies last year, Europe was far from favored by global investors.

For example, from 2005 to 2009, while Asian mutual funds were racking up $476 billion in net inflows, European funds saw net outflows of $1 billion, according to Strategic Insight. During that period, total flows into local Asia long-term fund were $850 billion — almost 10 times larger than in those for Europe.

More recently, last year’s crisis in Greece and subsequent anxiety about Ireland, Spain, Portugal, Italy and other nations rattled markets.

Investors focused exclusively on the European market’s obvious risks and sold assets indiscriminately, ignoring the underlying opportunity of the European big picture.

European corporations today are in the early stages of a restructuring process that is both massive and unprecedented. Generally behind their U.S. counterparts in terms of cost structures, corporate governance and general business practices, European companies are coming to grips with the need to transform themselves.

They are reassessing operations, shedding non-core assets, moving production to lower-cost markets and reducing staff to productive levels. All this is being done to become more efficient and effective in world markets.

One example is Spain’s Grupo Prisa SA Ticker:(PRS). Among Europe’s largest media, entertainment and education conglomerates, it has launched an aggressive effort to reinforce its governance, reduce its leverage and refocus on a growth strategy for its core market of 700 million-plus consumers.

Others include Siemens AG Ticker:(SI), a venerable German conglomerate, and Schibsted ASA Ticker:(SCH.OL), a Norwegian media company. Each generated double-digit returns in last year’s fourth quarter via aggressive re-structuring initiatives.

Significant fortunes will be created by European management teams’ adapting to new market realities.

Our strategy for Europe is to identify underappreciated situations where a “catalyst” such as a restructuring powered by forward-looking management likely will unlock value. We then make long-term commitments to such situations so that value creation can play out.

PREMIUM ON GROWTH

There is no question that Asia’s growth has been phenomenal. However, investors are paying a premium for it, for example, an estimated 15 times earnings this year for China’s CSI 300 Index.

By comparison, the relevant indexes for France, Germany and Spain can be had for nearly one-third less, with each carrying an estimated valuation of 11 times earnings this year.

What’s more, as European companies in transition refocus on Asian opportunities, such companies become attractive plays on Asia but at much cheaper multiples than direct investments in Asia.

Concern is brewing that the Asia/China scene is becoming overheated. In March, HSBC reported that many global fund managers were turning lukewarm on Asia-Pacific ex Japan and less bullish on Greater China equities, due to inflation concerns.

But the European value story is only just emerging, and therein lies the opportunity for forward-looking, discerning advisers. Encourage your clients to check out Europe’s fire sale.

David Marcus is chief executive and chief investment officer of Evermore Global Advisors LLC.