April 2016 INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
Angelika Bolliger, CFA, Director, STOXX Ltd.
INNOVATIVE. GLOBAL. INDICES. STOXX LTD. 2
TABLE OF CONTENTS
1 Investing in Europe in 2016 3
2 The EURO STOXX 50 in spotlight 4
3 The EURO STOXX 50 from an Australian perspective 6
4 Conclusion 8
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
1 Investing in Europe in 2016
With Europe accounting for about 22% of global output1 and about 20% of listed global equity market capitalization, see Figure 1, the region has an important place in almost any strategic and tactical equity allocation. Further, research indicates that institutional investors in Asia and overseas have been increasing their strategic exposure to Europe since the beginning of the millennium because consultants advised to reduce formerly heavy domestic market exposure and embrace a truly internationally diversified investment approach: Per a recent Towers Watson’s Study representing over USD 35 trillion in pension assets, the average pension fund reduced domestic equity market exposure from as much as 65% in 1998 to 43% in 2015, see Figure 2.
FIGURE 1: EUROPE ACCOUNTS FOR 20% OF THE WORLD’S LISTED FIGURE 2: INSTITUTIONAL INVESTORS REDUCE OVEREXPOSURE EQUITY MARKET CAPITALIZATION TO DOMESTIC MARKET AND EMBRACE GLOBAL DIVERSIFICATION
Market capitalization of listed companies by region as % of world total
11%
9% 32% Eurozone Europe, other US Japan Australia 2% World, other
6% 40%
Sources: Finland; Bank of Finland; Italy: Borsa Italiana; Czech Republic, Source: Global Pension Assets Study 2016, Towers Watson, February Denmark and Sweden: Global Stock Markets Factbook, else: 2016 Worldbank. Data as of YE 2014
This means that for most large Australian investors the question is not if, but how to access the European market.
Vehicles based on benchmark indices such as the STOXX Europe 600, which cover all major European equity markets including the United Kingdom and Switzerland, remain important.
At the same time, a growing number of market participants have discovered the advantages of using vehicles that invest in the major European sub-regions, of which the Eurozone is the most important one. That is because vehicles based on Eurozone indices such as the EURO STOXX 50 facilitate currency hedging, and allow for easier tactical over- and underweighting of the Eurozone vs. the rest of Europe.
1 Source: IMF World Economic Outlook Database, October 2015 data
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
Both of these advantages have become more important:
For the first time since the creation of the European Union, members may choose (or, in the case of Greece, be forced) to leave the Union. Most prominently, the United Kingdom is preparing to vote on a “Brexit”, the voluntary withdrawal of the United Kingdom from the European Union, on June 23 2016. Such a Brexit might come with a significant repricing of British Pound denominated stocks and products alike, which could lead to more heterogeneous market fundamentals in Europe. As fundamentals get more dissimilar between the Eurozone and the rest of Europe, investors may find it intuitive and convenient to access the Eurozone via vehicles exclusively dedicated to this region, such as EURO STOXX 50 based vehicles.
Moreover, currency risk management has become an increasingly central aspect of portfolio management. One reason is technical: portfolio management tools have become a lot more sophisticated and investors can finally manage these risks more easily. But changes in macroeconomic and political environment play the biggest role: Since 2008, central bank and policy interventions have been major players stirring global capital flows, significantly affecting equity valuations and increasing exchange rate volatility, see Figure 3. Market participants expecting diverging central bank policies and continued instability in exchange rates find Eurozone-only vehicles a natural and convenient choice.
FIGURE 3:TIMES OF STABLE EXCHANGE RATES AMONG EUROPEAN CURRENICES MAY BE OVER
1.8 EUR / CHF 1.6 EUR / GBP 1.4 1.2
1.0 FXrates 0.8 0.6 0.4 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14
70% EUR / GBP Source:60% Bloomberg. Data from Dec. 13, 2002 to Mar. 16, 2016
day EUR / CHF - 50% 40% 30%
2 Annualized 60 20%The EURO STOXX 50 in spotlight
rolling volatility rolling volatility in FXrates 10% Since0% its launch in 1998, the EURO STOXX 50 index has been representing the performance of the Eurozone’s 50 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14 super-sector leading companies.
The index is well diversified by country and industry:
The historical country allocation within the index is shown below in Figure 4. France and Germany have the largest allocations and jointly represent about 70% of index weights. While the weight of France was quite stable at around 35%, Germany gained almost 6% in index weight over the period, which reflects the country’s economic outperformance. Further, Figure 4 shows that not all of the Eurozone’s 19 member countries are represented in the index: First, only twelve of these countries’ stock markets are large and liquid enough to be considered developed
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE stock markets and thus eligible for the EURO STOXX 50 index: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain2. And second, only nine of these countries are also home to super-sector leading companies. Greece or Portugal, for instance, have never in the EURO STOXX 50’s 28-year history been representative in the index. Using STOXX TRU data, which calculates economic country exposure not based on country of listing, but on origin of the revenue, just over half of the constituents generate the majority of their revenue in Europe. This means that investors in the EURO STOXX 50 obtain meaningful global diversification, too.
Among industries, Financials represent the largest industry with a 23% allocation, with Consumer Goods and Industrials coming in second and third, with about 19% and 13% of weights, respectively, see Figure 5. The allocation of Financials has decreased significantly from its pre-crisis peak of 41%: Since then, the allocations to Consumer Goods and Industrials have each more than doubled, driven in particular by the success of Belgian, French and Dutch leaders such as Anheuser Busch, Unilever and LVMH Moët Hennessy for Consumer Goods, as well as by Germany-based leaders such as Siemens, Daimler and BMW for Industrials.
FIGURE 4: COUNTRY ALLOCATIONS LED BY FRANCE, WITH FIGURE 5: FINANCIALS REMAIN LARGEST INDUSTRY, WITH GERMANY CATCHING UP CONSUMER GOODS AND INDUSTRIALS GAINING GROUND
EURO STOXX 50 country allocation over time in % EURO STOXX 50 industry allocation over time in % 100 100 Luxembourg Consumer Services 90 90 Ireland Utilities 80 80 Finland Telecommunications 70 70 Technology Belgium 60 60 Health Care 50 Italy 50 Oil & Gas 40 Netherlands 40 Basic Materials 30 Spain 30 Industrials 20 20 Germany Consumer Goods 10 10 France Financials 0 0 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16
Source: STOXX. Monthly data from Mar. 2006 to Mar. 2016 Source: STOXX. Monthly data from Mar. 2006 to Mar. 2016
EURO STOXX 50 index is comprised of highly liquid large caps which include globally successful brands such as Aspirin, Budweiser or Mercedes, to name a few. As shown in Figure 6, it is broadly diversified at the constituent level, with no component currently exceeding an index weight of 5.0%, and with the top 10 stocks jointly accounting for only 38.0%. Based on the index’s methodology, components are capped at 10%.
2 This definition excludes several smaller and less liquid markets that also form part of the Eurozone, such as Estonia or Malta.
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
FIGURE 6: EURO STOXX 50 OFFERS BROAD DIVERSIFICATION DOWN TO THE COMPONENT LEVEL
EURO STOXX 50 top 10 index components # Name Weight Market cap. in EUR bn Country Industry 1 Total 5.0% 98.3 France Oil & Gas 2 Bayer AG 4.3% 85.4 Germany Basic Materials 3 Sanofi 4.3% 84.2 France Health Care 4 Anheuser-Busch InBev 4.2% 83.8 Belgium Consumer Goods 5 Siemens 3.8% 74.7 Germany Industrials 6 SAP 3.5% 69.9 Germany Technology 7 Daimler AG 3.4% 67.1 Germany Consumer Goods 8 Allianz 3.3% 65.3 Germany Financials 9 Unilever 3.1% 61.5 Netherlands Consumer Goods 10 BASF 3.1% 60.9 Germany Basic Materials Sum of top 10 38.0% 751.3
Source: STOXX. Monthly data from Mar. 2006 to Mar. 2016
On aggregate, all EURO STOXX 50 components represent about EUR 2.0 trillion, or approximately 60% of the Eurozone’s total stock market capitalization.
Lastly and very importantly from a practitioner’s perspective, the EURO STOXX 50 is by far the Eurozone’s most liquid index. In 2015, over 700 million options and futures contracts that were based on the EURO STOXX 503 were traded. This unrivalled liquidity means that EURO STOXX 50-based products can be hedged at extremely attractive costs.
3 The EURO STOXX 50 from an Australian perspective
There are some structural differences between the Australian and the Eurozone stock market. Most notably, the Eurozone is a larger and better diversified economic region than Australia.
With over USD 10 trillion GDP, the countries represented in the EURO STOXX 50 produce over eight times the economic output of Australia4, and these Eurozone countries have listed equity markets that account for 11% of world total vs. Australia’s 2%, see Figure 1. As market size and liquidity strongly correlate, this explains why the Eurozone’s EURO STOXX 50 is much more liquid than commonly used Australian indices.
3 Source: STOXX, Deutsche Börse AG 4 Source: IMF World Economic Outlook October 2015, using Gross domestic product, current prices in US dollars for year end 2015
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
Further, the Eurozone is more heterogeneous than Australia from a cultural and economic perspective, which also translates into the EURO STOXX 50 offering superior diversification by industry. As Figure 7 shows, less than a quarter of EURO STOXX 50 weights are allocated in any one industry and all but one industry has a weight of over 5%. In Australia’s S&P/ASX 200 on the other hand, almost half of the market capitalization is concentrated in just one industry - Financials - and only one in two industries has a weight of over 5%.
The Eurozone also offers better diversification at a company level: A comparison of Figure 6 with Figure 8 below shows that in Australia, a higher percentage of weights is concentrated in the country’s largest stocks. This means that standard Australian benchmarks exhibit more idiosyncratic risk than the Eurozone’s EURO STOXX 50.
FIGURE 7: BETTER INDUSTRY DIVERSIFICATION VS. AUSTRALIAN Figure 8: STANDARD AUSTRLIAN INDICES FEATURE RELATIVELY MARKET HIGH WEIGHTS IN LARGEST STOCKS
Industry allocation in % S&P/ASX 200 Index top 10 components
Financials # Name Weight Market cap. Industry in % in AUD bn Consumer Services 1 COMMONW. BANK OF AUSTR. 9.5 127.9 Financials Industrials 2 WESTPAC BANKING CORP. 7.5 101.2 Financials Basic Materials 3 NATIONAL AUSTRALIA BANK 5.1 69.2 Financials Health Care 4 AUSTRALIA AND NZ BANKING 5.1 68.4 Financials Telecommunications 5 TELSTRA CORP. 4.8 65.2 Telecomm. Oil & Gas 6 BHP BILLITON LTD 4.0 54.1 Basic Materials Utilities 7 CSL LTD 3.5 46.9 Health Care Consumer Goods 8 WESFARMERS LTD 3.5 46.7 Consumer Services Technology 9 WOOLWORTHS LTD 2.1 28.1 Consumer Services 0 10 20 30 40 50 10 SCENTRE GROUP 1.8 23.6 Financials S&P ASX 200 EURO STOXX 50 Sum of top 10 46.7 631.5
Source: STOXX, Bloomberg using ICB industry classification scheme. Source: Bloomberg, using ICB industry classification scheme. Data as Data as of Mar. 31, 2016 of Mar. 31, 2016
From a returns perspective, the Australian stock market has been performing in line with the Eurozone over the past five years, see Figure 9. Risk, as measured by volatility and maximum drawdown, has been lower in Australia, despite better structural diversification of the Eurozone. Political tensions among the Eurozone members may explain much of this this observation. On the flipside, the higher perceived political risks in the Eurozone has kept pricing more attractive than in Australia, as evidenced by the EURO STOXX 50’s more attractive fundamental ratios and real yield. And lastly, the numbers show that there remains a strong case for Australian investors to diversify into the Eurozone, with correlations between the two regions being remarkably low: Even when calculating correlations over long (i.e. monthly) periods, the correlation between the S&P/ASX 200 index and EURO STOXX 50 index (in AUD) is only 0.42.
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
FIGURE 9: COMPARISON OF AUSTRALIAN AND EUROZONE STOCK MARKET PERFORMANCE AND KEY FIGURES UNDERPINSTHE CASE FOR DIVERSIFICATION INTO AND ATTRACTIVE VALUATION OF THE EUROZONE
EURO 180 S&P/ASX 200 EURO STOXX C STOXX 50 Index 50 Index Index 160 h
Net AUD Net aAUD 140 Net EUR Return, 3.7% 3.6%r 2.6% 120 annualized Volatility, 12.5% 17.8%t 18.4% annualized 100 Maximum drawdown -20.5% -34.3% -32.3% 80 Correlation o 1.00 0.17 0.28 (daily returns) r 60 Correlation 1.00 0.42 0.59 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 (monthly returns) S&P/ASX 200 Index - Net AUD Price to earnings 22.5 19.9I 19.9 EURO STOXX 50 Index - Net AUD Price to sales 2.5 1.2m 1.2 EURO STOXX 50 Index - Net EUR Price to book 1.8 1.4a 1.4 Real gross dividend 3.0 nag 4.4 yield5 e
Source: STOXX, Bloomberg. Daily data from Mar. 31, 2011 to Mar. 31, 2016. Fundamentals including dividend yield as of Mar. 31, 2016
4 Conclusion
As highlighted, the Eurozone as represented by the EURO STOXX 50 index can provide access to globally successful brands with a wide diversification among industries and companies not as readily accessible in the Australian market. Further, the size of the Eurozone listed equity markets translates to a deep and liquid market, meaning EURO STOXX 50 based products can be hedged at extremely attractive costs.
5 Using 12m trailing index dividend yield minus Australian and German generic two year government bond yield, respectively
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INVESTING IN EUROPE USING THE EURO STOXX 50: AN AUSTRALIAN PERSPECTIVE
About STOXX Limited
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