Large Caps Shine on European Horizon

Years in the making, the euro is now just five weeks away.

On Jan. 4, 11 European nations--led by Germany, France and the Netherlands--take the radical step of adopting a single currency.

But stock investors shouldn’t get too excited about the date.

Owners of European shares have been profiting for at least two years from anticipation of the euro and the economic reforms and efficiencies it is expected to bring. So the actual arrival of the currency may not make the region immediately more attractive to investors.

Notes Jean-Marie Eveillard, manager of the $2.9-billion SoGen International fund, which invests about a quarter of its assets in Europe, “It has been so obvious for more than a year that it would arrive on time, that [the euro] has already been discounted” into stock prices.

Having said that, for U.S. investors looking to put money to work, Europe remains an immensely attractive region--especially for those with a long-term view, many money managers argue.

“Europe is where the U.S. was in the early 1980s” in terms of the restructuring of its corporate sector, said Chris Orndorff, head of equities for the Los Angeles-based money management firm Payden & Rygel, which recently formed a joint venture with a German bank that will focus on Europe.

Expectations abound. A low interest rate environment, virtually assured by the creation of a single European central bank--which begins setting interest rates for the region Jan. 1--should spur economic development, analysts say. It should also be beneficial to the region’s financial-services firms.

Extending Corporate Restructurings

The removal of currency concerns should spur cross-border trade among the 11 member nations of the European Monetary Union. This in turn should prolong the unprecedented wave of corporate restructurings spreading throughout the continent.

Why? As companies that currently enjoy local or regional dominance face new competition, they will be forced to merge, acquire and/or restructure to keep up. “The fact is, there are still tremendous efficiencies to be gained in Europe” at the company level, Orndorff said.

All of this--plus the region’s move toward a private pension system based on the U.S. model in which individuals are responsible for their own investment decisions--is expected to continue fostering an “equity culture” throughout Europe.

Of course, “it’s not all going to happen on Jan. 4,” said Larry Speidell, director of global research for Nicholas-Applegate in San Diego. Indeed, though the euro will come into existence on Jan. 4--and companies will do business in euros--each member country will still retain its currency until 2002. Those currencies will simply be pegged to the euro.

Much also depends on how smoothly the transition goes. And that’s dependent on how well the economies of Western Europe hold up.

Already, expectations of European growth are falling in light of continuing global economic uncertainty. At the end of October, brokerage Salomon Smith Barney cut its forecast for real growth in 1999 European gross domestic product from 2% to 1.6%.

The projections could fall even further. “If the euro is strong relative to the dollar, exports, a driver of Europe’s growth, are going to be hurt,” said Leila Heckman, managing director in charge of global asset allocation for Salomon Smith Barney in New York. And in the new Europe, individual governments in the EMU can’t use monetary policy to jump-start their economies. “This is the role of the central bank,” Eveillard noted. “And they could not do much in terms of fiscal policy, because of the constraints of [the] Maastricht [treaty],” which set the economic terms and hurdles for entry into the monetary union.

Meanwhile, from a stock valuation viewpoint, many European markets’ average price-to-earnings ratios are nearly as lofty as U.S. P/Es, some analysts warn.

Sticking With Europe’s Blue Chips

So, do the concerns outweigh the hopes? Probably not, many analysts argue. But if investors are concerned, they should consider sticking with big, blue-chip European stocks, money managers say.

True, European blue chips have enjoyed a major run-up over the past couple of years, the late-summer slide in global markets notwithstanding.

Over the past 12 months, for instance, the German stock market has shot up 22%; Spain has soared 38%, and Italy is up nearly 49%. Over the past five years, the average mutual fund that invests in European stocks has returned more than 17% a year. That’s slightly more than the return of the average U.S. stock fund.

But even value-minded managers believe that large caps are likely to shine in the months following the euro’s arrival. The euro is expected to encourage cross-border investments among EMU member nations. Since many investors who venture into new markets will seek safety, they are more likely to move into liquid, large-cap names that are best able to deal with new competitive pressures.

To find funds poised to benefit most from the euro, we studied fund tracker Morningstar’s universe of 107 European stock funds.

Just because a fund has “Europe” in its name doesn’t mean it invests exclusively in European companies. Indeed, some Europe funds stash as much as a third of their assets elsewhere. So we screened out all funds from our list that didn’t have at least 80% of their assets invested in the region.

Then we tossed out all funds whose year-to-date, 12-month, and three-year annualized returns were below the category averages. That left us with 19 funds.

We then screened for two specific characteristics. First, on the theory that blue chips will outperform in the new Europe, we sought funds that invest in companies with a median market capitalization of at least $7 billion.

Next, on the theory that the financial sector is set to benefit most from the new and burgeoning capital markets in Europe, we made sure that the rest of our funds had at least 20% of their stake in financial-services stocks.

This left us with 10 funds. We threw out one of them, the $35-million Fidelity Germany fund, because it focused on a single country. We also threw out $1.9-billion Morgan Stanley Dean Witter European Growth (B shares), because its 2.42% annual expense ratio was a third greater than its category peers.

The remaining eight are listed below in order of year-to-date total returns:

* Bartlett Europe A (4.75% load; minimum initial investment: $1,000; [800] 800-3609). For years, Bartlett Europe was a forgettable fund. Indeed, in five of its first six years, it finished in the bottom half of its category.

But over the last one, three and five years, the fund beat 96% of its peers. What changed? For one thing, this $50-million fund recently converted from closed-end status, meaning its limited number of shares were exchange-traded like stocks, to open-end status with unlimited shares.

More important, the management team hired in 1992 made some good stock picks. And because the managers pared down the portfolio--the fund holds just 51 stocks--that increased the effect each winner had.

Recently, Bartlett held more than 41% of its assets in financial-services stocks, such as Bank of Ireland and Credito Italiano--helping generate impressive year-to-date returns of 34.9%.

* Invesco European (no load; $1,000; [800] 525-8085). Investors seeking European growth stocks will certainly find them in this $674-million fund, which recently had two-thirds of its money in three high-growth sectors: financial services, technology and telecommunications.

Among lead manager Steven Chamberlain’s recent top holdings were telecom plays Nokia and Mannesman, the latter a “big and fast-growing player in Germany’s underpenetrated cellular market,” according to Morningstar analyst Bill Rocco.

* Vanguard European Stock Index (no load; $3,000; [800] 662-7447). For investors looking to own European equities via a “passive” index fund, this $4.2-billion fund tracks the Morgan Stanley Capital International Europe index, dominated by large-cap stocks.

Helped by the restructurings undertaken by many of those firms in the index in recent years--and thanks to expenses that are 83% lower than that of the typical Europe fund--this fund’s portfolio has generated three-year average annual returns of 24.4%, putting it among the top 6% of its peers.

* Scudder Greater Europe Growth (no load; $2,500; [800] 225-2470). This fund has been the darling of the Europe fund category of late, garnering most of the attention--thanks to its stellar performance--and tons of money.

In just the past two years, this $1-billion fund has seen its assets swell nearly 600%. Which leads to the question: Can lead manager Carol Franklin find enough attractive stocks to put all that new money to work?

So far, so good. Some of the money was used to make first-time purchases in Greece, among the next in line to join the EMU. Among them: Alpha Credit Bank and National Bank of Greece.

* Chase Vista European A (4.75% load; $2,500; [800] 348-4782). Large stakes in the financial and service sectors have driven this $34-million fund to annualized returns of 24.7% over the past three years.

And even though it turns over its portfolio 136% more frequently than its average category peer, the fund is 52% less risky than the typical international stock fund, according to Morningstar.

* T. Rowe Price European Stock (no load; $2,500; [800] 638-5660). Big, blue-chip Europe-based multinationals--names like Royal Dutch Petroleum, Smithkline Beecham and Glaxo Wellcome--dominate this $1.3-billion fund, just as they do the MSCI Europe index.

The result: The fund finished among the top half of its peers for the last four consecutive years. Over the last three years, the fund has delivered annualized returns of 22.5%.

* Fidelity Europe Capital Appreciation (3% load; $2,500; [800] 544-8888). This $650-million fund goes after beaten-down stocks in hopes of catching them on the rebound. And it trades stocks frequently.

With this approach, the fund has edged out its sibling, Fidelity Europe, delivering three-year annualized returns of 23.7%.

A caveat: In recent months, the fund has been gravitating toward more mid-cap stocks, according to Morningstar analyst Kevin McDevitt. Though the fund’s median market capitalization is still nearly $10 billion, you may want to rethink this fund if that measure falls much below that.

* Fidelity Europe (3% load; $2,500; [800] 544-8888). Unlike Fidelity Europe Capital Appreciation, this $1.6-billion fund seeks out high-quality companies and adheres to a strict buy-and-hold strategy. That’s proved to be a winning formula over the last five years, with the fund delivering annualized returns of 19.6%.

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Cashing In on the Continent

Here are eight stock mutual funds focusing on European equities that have delivered above-average returns year to date, over the last 12 months and over the last three years. These funds all favor large-capitalization issues, which many experts believe will fare best with the dawn of the euro currency. Performance figures for three and five years are annualized:

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Year-to-date 3-year 5-year Fund total return ann. ret. ann. ret. Bartlett Europe A 34.9% 27.9% 21.1% Invesco European 27.6 24.7 18.9 Vanguard European Stock Index 25.5 24.4 20.7 Scudder Greater Europe Growth 23.5 26.4 NA Chase Vista European A 23.1 24.7 NA T. Rowe Price European Stock 22.3 22.5 19.9 Fidelity Europe Capital Appreciation 18.9 23.7 NA Fidelity Europe 17.4 22.4 19.6 Avg. Europe stock fund 15.2 19.9 17.0 Avg. U.S. stock fund 8.9 17.4 15.8

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Note: Return figures through Friday.

Source: Morningstar Inc.

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Fund Strategies considers tactics used to choose mutual funds. Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.