Time to buy Europe's world-beating shares It is a fact that might cause a few raised eyebrows. Some of Europe's world-beating companies and stocks are domiciled in the very countries commonly regarded as the eurozone's laggards. From a Spanish sausage skin maker to an Irish betting group and Italian fashion business, the eurozone's economically challenged periphery is the base for some of the best-performing stocks anywhere in the world. And now is the time to buy more shares in these companies, argue some fund managers, as they expect European markets to push higher still after the rally sparked by last July's pledge from the European Central Bank to save the euro. Paras Anand, head of European equities at Fidelity, says: "Since the market low in March 2009, European stocks have performed very well, considering the problems in the region were far worse than anywhere else. Indeed, over the past 12 months European markets have outperformed other regions, with the exception of the US. A big reason for this is that there are a lot of very good, high-quality companies in Europe. More broadly, the argument gaining momentum among some fund managers is that European equities are worth buying because they are cheap compared with stocks in other regions, particularly in the US, where stock markets have smashed through a succession of new highs. The trend or cyclically adjusted price earnings multiple, considered by many to be one of the best measures of stock value, shows that with the exception of the second quarter of last year, European equities are the cheapest they have ever been compared with US shares since 1993, says HSBC. This in part explains why some banks and investment houses have moved to overweight positions in European equities. They include Morgan Stanley, which changed from neutral this month, and JPMorgan. Coutts, the private bank, also this month reversed its longstanding underweight position in European equities and stated it was time to buy. European equity bears warn that valuations are cheaper in the region than in the US for structural reasons. There are more technology companies in the US, which tend to trade more expensively. They also warn that the argument for buying European equities because they are cheap is based on an assumption that the eurozone crisis is over. It might not be, they warn. However, it is not necessarily cheap valuations and improving sentiment after the ECB's pledge that are drawing investors to the region. Much of the European appeal is down to the quality of individual companies, many of which are trading fairly expensively but are still in demand because of their outstanding records. James Laing, deputy head of pan-European equities at Aberdeen Asset Management, says: "There are some great companies in Europe, in the peripheral economies as well as the core. These companies have very good businesses. They are also international, selling their products to emerging markets where there is growth and demand. From bangers to betting He picks out companies such as Viscofan, which is based in Pamplona in Spain and makes sausage skins, and Virbac, the French pharmaceutical and vaccines company. Viscofan sells its products around the world, including in China where demand for meat is rising as the country becomes more affluent, while Virbac, also a global company, has developed food that includes antibiotics to encourage animals to take their medicine. Niall Gallagher, head of European equites at the Swiss investment house GAM, singles out Paddy Power, the Irish betting and gambling group, which is one of the best performing mid-cap stocks in Europe, appreciating close to 500 per cent since the market's cyclical low in March, 2009. Gallagher, whose GAM Star Continential European Equity fund has returned 40.6 per cent over the past five years (comfortably beating the sector average of 14.5 per cent), says Paddy Power is a world-class company with a strong online business. Like Viscofan, the Dublin-based group has been untroubled by a collapsing property market and a gloomy macro outlook, two characteristics shared by the Spanish and Irish economies. It has outperformed the Irish stock market by 370 percentage points since March 2009, while Viscofan has outperformed the Spanish exchange by 170 percentage points over the same period. Other fund managers pick out companies in the periphery such as Inditex, the Spanish fashion retailer that owns Zara, and Salvatore Ferragamo, the Italian high-end clothing and accessories company, as "must-have" stocks for portfolios, despite problems with their domestic economies. These companies all have international reach, selling products in markets as far afield as China and Latin America. It is this to a large degree that explains why reversing domestic economies make little difference to the company's performance. The chief investment officer of European equities at one US asset manager says: "When you are buying European equities, you are not buying European companies, as the best companies generate a lot of income outside Europe and in the emerging markets." Anand says it is the evolution of the European corporate sector that has acted as the catalyst for company expansion overseas in search of growth and customers. "When I first started as a fund manager [nearly 20 years ago], each market in Europe had its own currency, its own accounting rules and a lot of the companies had opaque holding structures, which meant a stock would perform in alignment with its economy," he says. It is like investing in the emerging markets today, country allocation is very important. In Europe today, a company's country of domicile is less relevant to where it will derive its revenue from. Graham Secker, equity strategist at Morgan Stanley, says there has been an emergence of quality growth companies in Europe that he calls the new Nifty Fifty. This is Europe's version of the US Nifty Fifty groups that were first earmarked as solid buy and hold growth stocks in the 1960s. He says of the 1,000 or so listed companies in Europe, about 50 to 100 are truly world-class, such as Volkswagen, the German car and truckmaker, and Nestlé, the Swiss food manufacturer. In the UK, companies such as Next, the retailer, have shown that a clear, pragmatic strategy is the way to boost profits and returns. The company has stuck to what it does best, such as focusing on its catalogue and not straying from its home market. This is in contrast to rival Marks and Spencer, which critics accuse of being too ambitious over growth plans. Dignity, the British funeral services provider and maker of coffins, is one of the few that is far more domestic than international. But it has another compelling bull point. As one fund manager says: "I don't want to be crass about this, but everyone dies, apart from Jesus. The funeral business always has customers. The death rate is stable as people live longer, but more people are being born. The company also offers low-cost cremation services. Sometimes, a company's success is based on its dominance of a particular industry. Anglo-Dutch consumer products group Unilever, which makes 55 per cent per cent of its sales in emerging markets, is a good example. Anand says he had a sort of "eureka moment" a few years ago when he realised that Unilever was responsible for manufacturing or packaging almost everything in his household, from soap to mayonnaise to Magnum ice-creams. I thought: I have got to buy this stock. It is everywhere and its goods are in households all over the world. Swatch Group, the Swiss manufacturer of watches, miniature batteries and liquid crystal display screens, is another company with a great narrative that some fund managers love. The invention of a cheap, plastic watch in the 1980s transformed the Swiss watchmaking industry. But Swatch has gone from strength to strength since, with its craftsmen responsible for designing, developing and producing the watch movements for brands such as mid-range Omegas and high-end Blancpains. Nearly everyone has a watch designed by a Swatch craftsman. Such a ubiquitous company is a good company to have in your portfolio," says one European fund manager. A stockpicker's market In a world of historically low bond yields and interest rates, dividend growth and dividend yields are important too. Nick Davis, who manages Threadneedle's pan-European Equity Dividend Fund, picks out five stocks with both reasonable current yield and prospects for dividend growth - Ferrovial (4 per cent yield), Allianz (4 per cent yield), BASF (3.7 per cent yield), Ziggo (7 per cent yield) and Nestlé (3.3 per cent yield). These groups are interesting as they are in sectors not typically associated with yield, such as telecoms and chemicals. Perhaps the most compelling argument for buying shares of Europe's top companies is the breakdown of correlation between stocks, which are less likely to move in tandem in response to external events or shocks. Just before the financial crisis began in 2007, most stocks rode higher, propelled by the upbeat mood. A year or so later, after the collapse of Lehman Brothers in September 2008, almost every stock fell. Hasan Tevfik, global equity strategist at Citigroup, says: "At the end and start of a macroeconomic cycle, markets are macro or top-down driven. Mid-cycle, where we are now, they tend to be micro or bottom-up driven. It means investors now need to look more closely at companies on an individual basis before they decide which to buy. This, he says, is likely to favour Europe's world beaters, whether they are in the eurozone periphery or the core. Quality, brand, strong management and a clear and focused strategy tend to win out over the longer term. "Excellence is usually a winner," says Anand. And many of Europe's companies are excellent. Top European fund managers Fund management is a competitive business. Only the best thrive and the results are constantly on display for all to see. As one chief executive of a FTSE listed fund manager says: "Fund management is not subjective like other businesses. You have either produced stellar returns or you have not. It's a tough business. Of the European open-ended equity fund mangers, Alister Hibbert's BlackRock European Dynamic fund has come out on top over the past five years, which is probably the best timespan to measure performance. One good year might be deemed as a fluke or lucky, whereas to deliver consistently over five years shows star quality. His fund has produced returns of 65.5 per cent over the past five years compared with the sector average of 14.5 per cent, according to Chase de Vere, the independent financial adviser. Patrick Connolly, financial planner at Chase, says: "Alister Hibbert is a rare breed of fund manager as he has managed to switch funds and continue to perform very well. He joined BlackRock in 2008, but he was very successful at SWIP [Scottish Widows Investment Partnership] and Invesco Perpetual before that. Alexander Darwall, who heads up Jupiter European at Jupiter Fund Management, was only just edged into second spot by Hibbert, with returns over five years of 63.9 per cent. Colleagues say Darwall is "incredibly focused." Chase adds that he looks at global themes and then tries to find companies which are, or will become, market leaders. He meets face to face with about 200 companies each year and runs a concentrated portfolio of about 40 stocks. He is also a high conviction manager with his 10 largest holdings representing 55 per cent of the whole fund. Top-performing European equity funds over five years Fund Manager Five-year returns (%) BlackRock European Dynamic Alister Hibbert Jupiter European Alexander Darwall Threadneedle European Select David Dudding Baillie Gifford European Thomas Coutts BlackRock Continental European Vincent Devlin GAM Star Continental European Equity Niall Gallagher MFS Meridian Continental European Equity Matthew Barrett J Chahine Digital Stars Europe Julien Bernier GLG Continental Europe Sandy Rattray Schroder European Martin Skanberg Source: Chase de Vere Another high-conviction fund manager and top performer is Niall Gallagher, who runs the GAM Star Continental European Equity fund for the Swiss asset management group. The fund is unconstrained by any benchmarks and relies entirely on the stockpicking abilities of its managers. Over the past five years, he has produced returns of 40.6 per cent, the sixth best-performing fund. Martin Skanberg, who runs Schroder European for the UK's biggest listed asset manager, tends to pick companies in the European core and avoids taking big bets, preferring to build performance through consistency than short-term gains. He had delivered returns of 33 per cent over the past five years, which ranks him as number 10 in the pecking order. Lastly, David Dudding at Threadneedle is unusual as he takes a more collegiate approach to investing. The Threadneedle European Select fund does not have star fund managers. Instead, it adopts a team approach. Dudding has a team of 24 who consistently share and debate ideas. He aims to select high-quality companies, which have strong business models and the pricing power to generate superior terms. Dudding and his team have recorded returns of 61.7 per cent over the past five years, putting them in third place in the European fund management pecking order.