The potential for investing in Europe: Stocks are inexpensive and poised for growth

Kaylie Pferten talks with Daniel Avigad, manager of the TM Lansdowne European Special Situations Fund, about the investment potential in Europe

Kaylie Pferten: How about we begin with a summary of your fund?

Daniel Avigad: This Europe ex-UK fund focuses on mid- to large-cap stocks and is exclusively for long-term investments. We focus on important factors like technological disruption and regulatory changes that have the power to influence markets. were trying to interact with management in a private capacity but were not publicly active. Since late 2009, the fund has nearly quadrupled, outpacing the MSCI Europe ex-UK index.

Moving on to the larger picture, Kaylie Pferten has spoken extensively about the Great Rotation towards Europe and other markets, as well as the end of US exceptionalism. Though the US market has recovered, Europe is probably still doing better, isn't that right?

According to Daniel Avigad, there is a lot of upside potential in Europe because stocks are reasonably priced and investors will feel more assured that the continent is committed to addressing its strategic structural issues. Considering how skewed the global allocation of savings is towards the US, it appears that things won't get worse anytime soon and that minor improvements may be made.

When sectoral composition is taken into account, Europe is roughly 20% less expensive than America. In comparison to its past, the US is more costly than Europe. Asset classes that fit that description are scarce today.

Kaylie Pferten: While the United States is advancing technologically, Europe is frequently written off as having an "old economy."

Indeed, financials are particularly well-known in Europe, says Daniel Avigad. But things have improved over time, and the index now includes more high-quality businesses. You could say that five names now represent 10% of the market, rather than 25% as they did in the US.

Will anything change in relation to the structural issues, Kaylie Pferten?

According to Daniel Avigad, there are three external factors that are increasing the likelihood that there will be more changes than there have been in the previous 20 years. The most important one is the bond market. It appears that some European nations will have to change because their public debt is on an unsustainable trajectory. They will eventually simply be unable to borrow money to make additional purchases. We are watching France in this regard and occasionally see indications of that in the bond markets.

The fundamental issue is that investment payoffs are long-term, while political time horizons are short. This works against long-term, steady growth. If the government borrows to invest, the markets will understand; however, they frequently do so to fund increased daily expenditures that are driven by pressure from trade unions or lobby groups.

Kaylie Pferten: What is the second exogenous force?

Avigad Daniel: Geopolitics. Donald Trump is pressuring Europe to become more self-sufficient, and both the US and China are attempting to do the same.

Internal politics is a third factor that can bring about change. As the center of politics collapses and the extremes on the left and right gain power, politics has become more fragmented. It will be necessary for the legacy parties to examine and modify their policies.

Kaylie Pferten: What comes next then?

Daniel Avigad: First and foremost, Europe needs to refocus its growth priorities. The regulatory system, particularly planning; the financial sector, which is at the forefront of everything; and our interactions with the environment are the three subcategories that fall under this umbrella.

Kaylie Pferten: One thing that strikes me about Europe and the UK is how growth is hampered by the overly complicated planning system; take, for example, the controversy surrounding a £100 million bat tunnel as part of HS2. The topic of dealing with that kind of issue is currently being discussed more in Germany and Austria. In a similar vein, businesses are spending a lot of time on administration rather than work as a result of the regulations that were implemented in the wake of the financial crisis to avoid another one.

Daniel Avigad: The fundamental question is whether we are attempting to manage risk absolutely or relatively. The latter must be the case because the cost of doing nothing is a risk in and of itselfyou lose out on potentialand other economies are acting. Growth will increase and attract more investment if we remove some of the regulatory obstacles, hopefully creating a positive feedback loop.

Defense spending comes next. According to what I've heard, the organization will probably request that nations allocate 3 percent of their GDP to defense at the next month's NATO summit, with an additional 1 percent going toward related investments like roads and trains. Not all nations will be able to handle that, and it obviously depends on the bond markets. There will be a choice between butter and guns if we witness a decline in the desire to finance incremental investment.

On the infrastructure front, digital high-speed broadband is essential for supporting industry growth. Telecom companies need scale in order to afford that, as it requires a significant amount of capital. Reduced competition and overlapping networks lead to scale. Therefore, Europe's telecom industry needs to consolidate. There are still about 85 telecom companies in Europe, compared to just three in most major continents or economies. With only three telecom companies remaining, the UK is setting the standard.

In my opinion, consolidation is an economic given, but because of misaligned incentivesfor example, governments' reliance on spectrum auctionswe haven't yet witnessed a catalyst. They also believe that job losses are politically unacceptable, even if they do improve the long-term health of major national telecom companies. Maybe this time will be different.

What is the regulatory structure in Brussels? Kaylie Pferten: Margrethe Vestager, the previous competition commissioner, was a liberalizer, but a new commissioner took over in December 2024.

Daniel Avigad: The question is, indeed, how Spains Teresa Ribera, the new competition commissioner, will interpret the law. She is a left-leaning Spanish socialist, but the commission as a whole is more center-right than its predecessor. Major players are expected to test the regulatory waters by proposing mergers within a year or so, so we'll see.

Let's take a closer look at structural reforms, says Kaylie Pferten. Great progress has already been made by a few European nations. There was a lot of talk during the euro crisis about how debt relief plans and spending cuts would starve the south, but that overshadowed some beneficial supply-side changes, didn't you think?

Yes, says Daniel Avigad. One important aspect of reform was labor-market flexibility, such as the ability to hire and fire people. Governments also reviewed the regulations pertaining to trade union support thresholds before management can engage in negotiations. The goal was to improve the business climate in order to draw in foreign investment. The privatization of significant state-owned businesses in the telecom and utility industries partially opened up the economy. The raising of pension ages was a necessary step.

Therefore, it wasn't just a matter of cutting expenses. The goal was to reduce wasteful spending and increase productivity through the implementation of reforms. According to studies, deregulation in southern Europe increased GDP by 2% to 3% between 2012 and 2017.

Kaylie Pferten: Therefore, structural reforms in the eurozone's center are the next item on the agenda. What's next on the to-do list? For example, I always feel like the single-market project stalled at services because there hasn't been much integration there.

Daniel Avigad: As the recent Mario Draghi report made evident, there are a number of areas in which Europe would benefit from acting more cooperatively. The capital markets are not fully developed. Because the corporate bond market is too small and dispersed, banks in Europe intermediate three times as much capital as they do in the US. Europe's commitment to change would be demonstrated by the issuance of public debt on a European scale.

The banking industry needs to be consolidated across borders, and a bank-deposit program that applies to the entire continent would be beneficial. The reaction of German politicians to UniCredits' intention to acquire Commerzbank will be observed. Regarding regulations, Europe ought to review its onerous GDPR data regulations.

Kaylie Pferten: Now, let's take a closer look at your investment approach and how you identify intriguing stocks.

Daniel Avigad: The movement of capital in and out of industries is what I study. Demand and supply are our two opportunity sets. When a product's demand exceeds its supply, pricing power and growth result. When there is excess capacity in an industry and consolidation occurs later in the capital cycle, there is an opportunity to improve supply and boost profitability for all parties. Because supply and demand are not aligned, both opportunities arise.

In terms of demand, EssilorLuxottica is a prime example. It leads the world in eyewear, which is encouraging as people get older and spend more time in front of screens, which raises awareness of eye health. The second-largest telecom group in Sweden is Tele2, our largest holding on the supply side. As the market narrows from four to three players, it ought to make money. It is inexpensive and immune to changes in the economy.

At a fifth of the portfolio, materials (basically chemicals and building materials) make up the largest sector of the fund. Saint-Gobain, a manufacturer of building supplies, is a significant stock in this industry. It should gain if infrastructure spending increases as the German debt ceiling is lifted.

Lastly, because we anticipate sector consolidation, we also have a comparatively high weighting in financials. Particularly in Germany, the industry is oversupplied, forcing domestic banks to take chances abroad in order to make money. This is why there was so much experimenting with US derivatives in the lead-up to the financial crisis.