Do UK companies face a threat or an opportunity from the changes afoot in mainland Europe?
For as long as anyone has been in investor relations in the UK, a few assumptions have prevailed in respect to continental European equities that have allowed British arrogance to reign supreme. There's no true equity culture on the continent, runs the theory (and, indeed, the practice - at least until very recently); and this has produced small, thin, illiquid markets. A risk-averse approach to investment - by institutions and individuals alike - has steered money away from the equity markets toward government bonds and other safe, fixed-income investments. The resulting relative lack of stock market depth has in turn produced a level of analysis and research well below the standards of the UK, let alone the US.
In short, continental Europe has not been the place to raise equity capital, especially not for entrepreneurial, high-growth companies; and, given the relative lack of importance of equity, companies have got away with displaying an alarming lack of attention to their mostly domestic shareholders. Until the last few years, US and other international investors have been dismayed by the lack of consistent information flows and all this has skewed the competition for capital firmly in favor of the Anglo-Saxons.
It has also left the leading continental European financial centers like Paris, Frankfurt and Amsterdam trailing well behind London, regardless of the strength of those centers' industrial hinterlands. As a result, members of the financial and business communities in the UK retain a quiet confidence that London alone, of all the European capitals, has a financial infrastructure equal to the task of serving as the financial center for a united Europe of the future.
But is all this British confidence still justified? Or are UK companies about to find out the hard way that London has no God-given right to serve this function? The coming of the euro could produce a real advantage for companies in the euro zone. Some commentators are predicting that they might be set to become a much stronger pull for international investors than UK stocks that remain quoted in a minor currency. The pound, after all, may well end up a relative pipsqueak compared to the euro.
In short, are UK companies going to be left out of the club?
Fight for capital
Many observers believe so. But few companies in the UK seem to be taking the threat seriously at all. The claim is that as interest builds in the euro zone and the equity markets within it, UK companies - and institutions like the London Stock Exchange - risk losing their pride of place as the first among equals on the European corporate and financial scene. Many people have started referring to a 'wall of money' being directed toward continental European markets, raising the possibility of UK IROs really having to fight for their capital in the future.
Or is this just alarmist journalistic nonsense? Most UK opinion certainly seems to believe so. Companies and their advisors remain by-and-large content that the changes present more of an opportunity than a threat. They are generally dismissive of the notion that, with the bulk of Europe using the same currency, those on the periphery are bound to have to work harder to keep investor attention. They argue that the very process of integrating the European economies implies costly restructuring - although they accept that it will also eventually lead to a more efficient corporate sector. And anyway, no sensible pan-European index should omit the UK - just because it's outside Emu - or Switzerland, just because it's outside the EU.
But several, more cynical, UK fund managers - most, unfortunately, remain unwilling to be quoted - argue that the fact that so much change is needed, and is now starting to happen, makes the mainland European equity markets a mouth-watering prospect for investors searching for future value. And leading companies in countries that were beyond the scope of, say, US portfolio managers because of the disproportionate level of currency risk - Portugal and Greece, for example - will now be in the running for the world's much sought-after investment capital.
Currency charts
Evidence of all this comes in the latest Merrill Lynch Gallup Global Survey of portfolio managers. Respondents included nearly 70 institutions, accounting for total funds under management of $676 bn. Their 'favorite currency' over the next twelve months is still the dollar, with 48 percent selecting the greenback. But nearly as many - 41 percent - prefer the euro, leaving just 4 percent favoring the pound sterling and 7 percent plugging the yen.
More than that, continental Europe is the hunting ground of choice for US fund managers seeking international equity exposure, with bulls outnumbering bears by 46 percent on a three-month view; by 49 percent on a year's view. And among continental Europe's own fund managers, bulls of continental stocks outnumber bears by 69 percent.
This might seem to suggest that UK IROs really are going to face stiffer competition from their continental euro-denominated counterparts post January 1999. But there is a flipside: a fast-growing interest in equities among continental institutions will give UK companies a new prospect for marketing their stocks.
For David Peattie of BP's IR department in London, this represents a demonstrable opportunity. 'Continental Europe is one of my top three issues,' he says. 'We're looking at how we can grow our shareholder base there right now.'
Indeed, Peattie visited Paris a few weeks back, holding six one-on-one meetings with fund managers as well as hosting larger meetings over lunch. 'As a result, we hope some of them will buy our shares,' reports Peattie, who is struck both by how few UK companies take the trouble to visit continental markets and by the level of interest he found among French institutions in BP. 'This was the first time I'd noticed a real step-change - and one that will be irreversible - in terms of continental equity markets,' he reports.
Andrew Mills, IRO at Kingfisher plc and chairman of the UK Investor Relations Society, is also wary of the idea that the changes present a threat to UK companies; or indeed that they demand much action just yet. 'I think it's on - or slightly over - the horizon for now,' he says. 'Most UK companies focus on the US first, with Europe seen as a medium-term possible opportunity.' While Mills is familiar with the wall of money concept, he notes that growth in European markets will be from a very small base. And he cautions against exaggerating this issue.
There seems little danger of that. Malcolm Kitchen of ABN Amro Hoare Govett in London, who advises his firm's clients on IR, says his feeling is that UK companies are not really addressing the issue at all yet, although he concedes that there is some evidence of more interest in continental Europe from UK plc. 'Over the last couple of years I think we've been arranging more trips to places like Paris, Frankfurt and Geneva,' he says. 'I can't offer statistics, but there's certainly more activity in this area. And continental institutions are appearing on UK registers with bigger holdings.'
Just how the allocations of institutional holdings will change - whether they are US, UK, continental European, Asian or Pacific-based funds - will be largely influenced by the choice of benchmarks, in the opinion of Charles Palmer, a director at Gavin Anderson in London. 'Investors are heavily influenced by indices,' he notes. 'So it's going to be largely a question of where and how [UK companies] fall in these. There are Stoxx indices, for instance, covering solely companies that are within the euro zone and solely those outside. So we may see some investors move away from some UK companies if they are not in a selected index. Certainly the chosen benchmarks will have huge importance.'
So might this mean that we'll see UK companies scrambling to list on euro zone exchanges to ensure inclusion in all possible indices? It's no more than a 'vague possibility' in Palmer's view. 'And the huge critical mass that the UK has will still stand it in very good stead,' he notes. For Palmer the key to future developments will be the move to sectoral investment. He suggests that as sector indices develop we'll see a switch to sectoral economies rather than country ones. 'We'll end up with comparisons between, say, the pharmaceuticals sector in Europe and the financial sector, rather than between France and Germany,' he argues.
One region
Christian Koefoed-Nielsen is already well aware of this as are European retail stocks at JP Morgan in London. 'As the start of the euro zone approaches, we can look at Europe as one region for investing,' he says, which will imply huge changes in the way funds flow. 'In the past I might have taken the approach that since Holland makes up x percent of Europe, then x percent of the portfolio should be in Holland. I'd then work out which Dutch companies should be included. With the euro in operation, we'll be working out what percentage of Europe's total market cap is made up of, say, the banking sector. Then, instead of having to have one Italian bank, one Dutch, etc, we'll be finding the best banks to make up that percentage in the portfolio.'
On this basis, there will be tremendous movement of funds between companies - and countries - as institutions realign their portfolios to take account of the need for a pan-European approach. It's a process that's already under way, according to Koefoed-Nielsen. 'I used to tell portfolio managers which was the cheapest retailer in, say, France or Germany. Now the question is whether the French retailer is cheaper than the German one.'
Global reinforcement
For now, the UK will remain outside this process, as the reallocation will be within the euro zone. Alan Rubenstein, head of the pensions group at Morgan Stanley Dean Witter, accepts that 'Emu will increase sector allocation and global stocks will be reinforced.' And he says that if much of the euro zone moves to a European benchmark it will affect investment flows. But he does not expect UK pension funds to switch to a euro-benchmark even if sterling was tied to the euro. 'Currency risk would still be an issue so I don't think people will switch until we know for sure the UK is going in at a fixed rate.'
That may provide comfort for UK companies, given the importance of UK pension funds in their share registers. The statistics show the disproportionate size of these compared with continental ones and the portion of their holdings in equities. And the latest figures from Technimetrics would seem to suggest that equity funds under management in London are stronger than ever. But this still begs the question of whether the fundamental changes taking place will be negative or positive for UK plc. After all, London-based money does not necessarily imply investment is directed toward UK companies.
'It's arguable whether the UK will suffer or be a beneficiary,' says Koefoed-Nielsen. 'At the moment people tend to allocate Europe in line with the MSCI index, choosing to be underweight or overweight in the UK, for instance, using the MSCI as their benchmark. I guess there will be a two-way pull. There are going to be lots of restructuring opportunities on the Continent which will provide some interesting investing opportunities. But you can also build an argument that UK companies aren't going to face the huge costs of restructuring.'
Wall of money
Koefoed-Nielsen also acknowledges the wall of money, liquidity argument, noting the huge growth in mutual and pension fund activity on the Continent which could drive European asset prices upwards. According to Salomon Smith Barney, the last two years have seen rolling annual fund flows into continental European equities rise from about $5 bn to $70 bn. Mutual funds have doubled over four years and now stand at $1.8 trillion - half the level of the US but gaining fast. Mark Howdle at Salomon envisages an effective pan-European bourse developing by 2005. 'The euro zone is going to see a transition phase of partnership to a full union of stock markets,' he says. 'It will create such a vortex that non-Emu stocks.'
Mark Brown and his colleagues at ABN Amro in London, in their impressive three-volume work, The EMU Equity Landscape, take a different view. 'The largest 200 European stocks will increasingly be viewed and traded in a pan-European context,' they say. 'Those in the euro zone will be listed in euros from January 1, 1999, but we believe that even for those outside the euro zone the main quote will steadily gravitate to euros (before their currencies join the single currency) and so we draw no distinction between companies in the two blocs.'
But no-one argues with the pressure on continental Europe to fund its pension funds properly; and everyone expects the growth in equity investment - and cross-border equity investment in particular, to continue growing apace. 'The advent of the euro is expected to have a profound effect on sector and stock selection,' says Brown. 'Many investors will be free for the first time to construct equity portfolios across a wide range of sectors in a way long familiar to US and UK institutions.'
It may not yet be clear just how the expected pan-European investment approach will develop but everyone agrees it will require an acceleration of the process of harmonizing listing rules, accounting practices and the like. The jury is still out on whether the changes brought about by the euro and other factors will make the lives of UK IROs easier or harder. But if a true pan-European market is to develop, the UK's involvement is essential: it's too important a market to be allowed to stay outside. So those UK IROs might as well start working out how they are going to cope with the changes - positive or negative - sometime soon.