Although the overall market, as measured by the MSCI Europe index, achieved a mid-single digit return in euro terms, there were some marked fluctuations in market returns quarter by quarter as volatility flared and subsided. The final calendar quarter of 2018 saw European stock markets sell off sharply alongside other global equity markets, with major market drawdowns in October and December as trade tensions between the US and China and tighter US monetary policy rattled investor sentiment.

In a stark turnaround in fortunes, a mix of central bank dovishness and increased optimism on US-Chinese trade talks helped markets cement a super-charged start to 2019. The rally was fuelled by the change in tone from the US Federal Reserve, signalling a pause in its programme of interest rate rises. In Europe, the European Central Bank (ECB) played its part in further kicking the interest rate can down the road, with the first eurozone interest rate rise delayed further, from autumn 2019 to ‘not before 2020’.

European equities posted further positive returns in calendar Q2 despite a sizeable correction in equity markets in May. A shadow was cast by the developments in the US-China trade dispute, where the US portrayed China as stepping back from previous commitments. The tariff on $200 billion of Chinese imports was raised from 10 per cent to 25 per cent in early May. June was a big month for geopolitics and bond yields, where a further plunge in the latter saw many bond markets hit all-time low yields for ten-year bonds. Bond yields continued to fall, with the ten-year German yield falling below the deposit rate for the first time.

The period concluded amid mounting worries over global growth, including signs of a marked slowdown in the German economy. German GDP contracted 0.1 per cent quarter-on-quarter in Q2; industrial production slipped 1.1 per cent month-on-month in June; factory orders dropped 0.6 per cent in August and business confidence surveys showed weakness. Bond markets were incredibly strong, as exemplified by the Italian BTP 10-year yield falling below 1 per cent for the first time and the entire German Bund curve (even the 30-year government bond) falling into negative territory. Italian government bond yield levels were bolstered by the news of the Five Star and Democratic parties coming together to thwart Interior Minister Matteo Salvini’s attempt at full control. However, the partial inversion of the US Treasury yield curve naturally caused concern as an important recession indicator historically.

Value stocks have generally struggled since the Global Financial Crisis of 2008-2009 while growth and momentum stocks have flourished. These performance trends continued through the year and presented a major headwind for our value-biased European equity strategies. Our Continental European, large-cap European Concentrated Value (ECV) and all-cap European Select Values (ESV) strategies all significantly underperformed their respective benchmarks over the period.

ESV trailed the index courtesy of materially negative stock selection, although it retains a market-leading long-term track record. The consumer staples, materials and industrials sectors were areas of marked weakness for the portfolio, with steelmaker Thyssenkrupp, a cyclical stock, being a major laggard as its share price was buffeted by macro worries. Elsewhere, Aryzta, a Swiss-Irish baked goods company, lagged on disappointing earnings numbers. In general, the portfolio’s small cap names, which have historically been a meaningful source of outperformance, remained largely out of favour over the period despite compelling valuations.

ECV is a large cap stock-picking strategy that, like its ESV sister strategy, also combines traditional value and quality characteristics and targets companies generating high rates of return on capital employed. Weakness in names such as Thyssenkrupp, Rolls-Royce and Imerys eclipsed strength in holdings in Danone, Wolters Kluwer and Oracle.

After 10 years of a bull market, in order to find significant value fundamental investors are being forced to be contrarian, to own companies that others do not want to own. The valuation disparity between quality and classic value stocks is stretched. In the short term, this leaves the ECV and ESV strategies vulnerable to unpredictable relative performance. Nonetheless, the fund managers believe the latent value in both portfolios to be at multi-year highs.

Our Continental European Fund, which combines a top-down, sector-based approach with bottom-up stock-picking, was hurt by negative stock selection, particularly within the utilities sector where owning EDF was unhelpful, and in materials, where Finnish pulp and paper producer Stora Enso Ojy was the portfolio’s largest individual stock laggard. Sector allocation effects were also unfavourable, most notably being underweight the strong-performing consumer staples sector and overweight the energy sector.

Many investors chose to reduce their exposure to European markets because of the Continent’s lacklustre growth outlook and continued political uncertainty, with further political instability and the protracted Brexit negotiations continuing to undermine investor appetite for European equities. Coupled with the adverse performance of our European strategies, these asset allocation calls contributed to a highly disappointing picture on flows. The European Select Values and Continental European strategies experienced net outflows of £768 million and £612 million respectively, while the European Concentrated Value strategy had a more muted £146 million net outflow.