Watch now: The case for an improving outlook in Europe

After many years of being out of favour, the prospects for Europe are looking much more positive for a number of reasons. First, European defence spending is rising sharply to levels which seemed unlikely not long ago. In addition, we have seen Germany lift its fiscal debt brake, marking a major policy shift. These moves have significant implications for European spending and broader economic growth. More importantly, they signal that Europe is ready to act on some of its long-standing issues and we hope to see lower bureaucracy and tighter Europe-wide integration as a result.

Moreover, Europe’s GDP per capita is less than half that of the US. This is not due to lack of innovation, but because doing business in US states like Texas or California is much easier than in Germany or France, for example and this has stifled productivity in the EU. Initiatives like the Draghi report and efforts to cut red tape could help close that gap.

Europe also has a unique advantage: its savings rate. Europeans save substantially more than Americans, but much of that capital is held inefficiently in vehicles such as cash and life insurance products, meaning it can’t be recycled back into the real economy. Proposals for a pan-European ISA could unlock significant capital for growth.

European valuations are currently high relative to their own history but are low relative to the US, with European equities often trading at a discount simply because of where they’re listed, presenting opportunities for selective investors.

Nevertheless, risks remain. We think tariffs are likely to end up at much higher levels than the 2% historic rate, and supply-chain shifts to mitigate the impact could take years to materialise. Europe also faces persistent challenges like poor demographics and high government debt.

Given this backdrop, selectivity is key, and despite the headwinds, we are optimistic about the prospects for finding excellent equity investment opportunities in Europe.

A consistent investment approach

Our investment process is anchored in three core philosophies that guide portfolio construction and management. Firstly, we employ a bottom-up stock selection approach, so that the majority of our risk and return is driven by stock selection rather than macro factors, quantitative factors, sector allocation or currency positioning.

Secondly, we maintain a long-term perspective, typically holding positions for three to five years. This approach aligns with our expertise and reduces transaction costs, which is crucial as excessive trading consistently erodes returns in asset management.

Finally, we prioritise capital preservation through three key mechanisms: maintaining sector exposures within ±5% bands relative to the benchmark, running a portfolio without using borrowed money so its sensitivity to market movements is consistently less than 1.0 (this means that the portfolio is generally less risky compared to the market), and focusing rigorously on downside scenarios for individual holdings before considering upside potential.

Our investment process focuses on companies that consistently grow their dividends, as our research shows that these companies significantly outperform those that cut or merely maintain their dividends. We focus on businesses that exhibit strong fundamentals: disciplined capital allocation, structural growth drivers, cash generation capabilities and robust balance sheets.

Recent performance headwinds

Over the long term, our strategy has delivered on its objective of 1–2% annual outperformance post fees and has displayed strong defensiveness. We’ve outperformed the benchmark in every down year over the past 15 years.

However, performance this year has been disappointing. Around half of our underperformance year to date stems from stock-specific issues, notably a miscall on Novo Nordisk’s trial data. The stock has been recovering since and we’ve topped up our position, remaining confident in its long-term story, but we acknowledge the earlier mistake. The other half of our underperformance relates to broader factors including our defensive tilt in a rising market and being underweight Germany which has seen positive impacts from increased spending. Country dispersion has been unusually high recently; German companies have surged while French names have sold off due to political risks, regardless of their domestic exposure. We’ve used this divergence to add tactically to undervalued French names.

Sector-wise, our lack of exposure to defence has dampened performance. Historically, defence hasn’t fit our criteria for steady cash generation and dividend payers, but we keep an open mind. Meanwhile, AI-related holdings like Legrand and ASML have helped offset some losses.

We remain confident in our strategy for two key reasons. Firstly, while recent stock selection has been disappointing, our underlying dividend growth philosophy remains sound across 1, 3 and 5-year horizons, despite facing some stylistic headwinds.

Secondly, our research team remains a core strength. The strategy has seen different managers and market conditions, yet performance has remained solid over the long term thanks to the depth and quality of our analyst team, which continues to be a key asset.

Past performance is not a reliable indicator of future returns.
^{Source: Morningstar as at 30.09.2025, bid-bid, net income reinvested. ©2025 Morningstar Inc. All rights reserved. The FTSE World Europe ex-UK Index Total Return is a comparative index of the investment trust.}

Portfolio positioning

Our positioning remains aligned with our long-term philosophy: we seek to invest in companies with faster dividend growth, higher returns and more sustainable payouts than the broader market. That quality comes at a premium - our fund typically trades around 10% above market valuation. Currently, we’re near a valuation floor, and so we’re not making wholesale changes. We think that many of our holdings look more attractive than they did a year ago, relative to the market.

Sector, market cap and country exposures remain broadly stable, though we’ve seen a slight shift towards Europe in terms of revenue exposure. This reflects both our constructive view on Europe and stock-specific opportunities.

Our health care exposure is in line with the benchmark, with holdings in Roche, Novo Nordisk and Lonza. While US drug pricing reform is a concern, history suggests changes often do not materialise. We focus on fundamentals, rather than taking sector-wide bets.

France is our largest overweight at a country level, but we avoid domestic-heavy names. Instead, we hold global players with limited French exposure. Political uncertainty has created tactical buying opportunities, and we’ve added selectively.

A positive outlook for Europe

Europe has kept pace with global markets over the past 30 years despite challenges like Brexit, the threat of Grexit, and the eurozone crisis. The reason for this is that European companies are not direct proxies for the region’s economy. Firms like SAP and L’Oréal have thrived globally because they’re industry leaders. Two-thirds of European revenues come from outside the region, providing a substantial tailwind. If domestic Europe - the remaining one-third of those revenues - starts contributing meaningfully given the positive outlook, the upside could be significant.

This year has been disappointing in terms of performance, but our philosophy, research capabilities and long-term approach remain intact, and we continue to be confident in our ability to deliver long-term outperformance.