According to a fund manager who specializes in European equities, there are plenty of opportunities in the Old World for the patient, quality-oriented investor, says Ben Shepherd of Investing Daily.
With all the structural problems plaguing European economies, most investors now take a dim view toward the continent.
But Matthew Benkendorf, manager of Virtus Greater European Opportunities (VGEAX), has successfully navigated these treacherous markets. His fund ranks among the top 1% of European equity funds, according to Morningstar.
We recently spoke with Benkendorf about his outlook for the region.
Ben Shepherd: What is your outlook for Europe?
Matthew Benkendorf: Europe made a critical error with its response to the 2008 credit crisis.
During that crisis, the US initiated programs such as the Troubled Asset Relief Program (TARP), which it used to infuse banks with capital. Although that may not have been the intended purpose of TARP, injecting banks with capital and then forcing them to raise additional capital turned out to be the right course of action.
European banks did raise some capital at that point in time, but they didn’t do so to the fullest extent necessary. Instead they took a piecemeal approach, with the hope that the resulting growth from an eventual economic recovery would obviate the need for additional borrowing.
Even after the equity markets finally rallied off their lows, European regulators failed to push the banks to strengthen their balance sheets by raising additional capital.
One can draw a simple contrast between the relative strength of US and European banks with basic metrics. In terms of tangible common equity (TCE), US banks are roughly twice as capitalized as European banks. On average, European banks are at 3% TCE to assets, while US banks are at about 6%.
It’s difficult to know the right level of capitalization, but the market’s action suggests that European banks need more capital. Unfortunately, it’s far more difficult for banks to raise capital from exiting shareholders after the market sell-off.
Beyond that, most entities take a risk-weighted approach to judging a bank’s capital needs. That risk-weighted methodology examines a bank’s asset base and discounts its assets according to their perceived risk levels.
Under that system, sovereign debt isn’t discounted—it’s considered sacrosanct, because it is theoretically redeemable with no risk. Of course, those assets do carry risk and, considering the risk to certain sovereign bonds such as those issued by Greece, the banks probably aren’t sufficiently capitalized to endure losses on those bonds.
Many politicians in Europe are being disingenuous when they say Greece won’t default on its bonds. Greece has over $300 billion in outstanding debt, and there’s no way the country can continue to make payments on it.
You can’t expect an economy or a population to shoulder that burden, and the Greek population isn’t going to struggle for the next 100 years to pay back Europe for its folly in offering them cheap financing for so many years. There will be social revolt before that happens, and we’re already seeing signs of unrest.
Although most politicians would likely deny it, default is obviously the endgame. For now, politicians are simply trying to buy some time and hoping for the situation to improve. They’re just delaying the inevitable.