European equities, unloved for much of 2022, have been among the best performers in 2023. Looking at the flows, investors have moved into the region at a sustained rate, while ESG exposures have also kept pace. And amid an improving outlook, as reflected by strong performance YTD, investors have spotted an opportunity in Europe given an easing of the energy crisis, relatively attractive valuations and China’s reopening.
Positive flows into EMEA-domiciled equity ETFs continued in February despite the challenging inflation backdrop that stopped the risk-on rally. European equity strategies gathered $2.3 billion of inflows in February – the highest monthly figure in a year. These flows contributed to a 2.5% YTD rise in AUM for European equity strategies, highlighting investors’ shift toward unloved markets from 2022.
During the month, divergence remained as European equities (MSCI EMU Index +1.6%) coped better than their US peers (S&P 500 Index -2.5%). The easing energy crisis, better-than-expected manufacturing data and relatively attractive valuations are still among the positive catalysts for this outperformance. Nevertheless, recession remains a key risk to monitor should the ECB tighten too aggressively.
Flows by Equity Regions
Interestingly, ESG equity ETP flows remained consistent with $675 million added in February across European exposures. These flows reflect investors’ continued support for ESG-focused ETFs, which gathered $54 billion of net new assets in 2022. And that occurred despite underperformance versus broad market indices during the year, primarily due to an underweight in energy. Furthermore, according to the Bloomberg Intelligence Global Asset Managers Outlook, European-domiciled ESG ETF flows and total asset levels will likely continue to drive demand, primarily led by favourable policies in the region.
Monthly Net Inflows to European Exposures by ESG Focus
Opportunities remain within European equities. This segment of the equity market has enjoyed strong performance since the beginning of the year, with the MSCI Europe Index rising 8.7%, while MSCI World has returned 4.5%1. The relative outperformance reflects the better outlook from investors for European economies, which has been driven by several improvements.
First, forward planning by governments and a relatively mild winter have allowed countries to avoid the feared energy crisis and forced electricity cuts as spot gas prices moderated to levels below €502 – a level not seen since the beginning of the war in Ukraine. Second, China reopening is expected provide a boost to global trade, with a potentially stronger impact on Europe than the US. Companies in the MSCI Europe Index derive 6.6% of their revenues from China and their growth is particularly dependent on China’s manufacturing and the burgeoning middle class’s spending on luxury goods (where European companies count among the world leaders). Third, January saw an improvement in investor sentiment, which lifted Europe in particular as it is a “value” region along with robust earnings yield premium over local bonds.
12-Month Forward Earnings Yield Spread over 10-Year Local Government Bond Yields
1 Source: Bloomberg Finance L.P., as of 28 February 2023.
2 Source: Bloomberg Finance L.P., as of 28 February 2023. ICE Endex Dutch TTF Gas Spot Price – Next Hour.
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