Europe might seem too treacherous for investors just now. The region's broader stock market is down more than 20 percent so far this year. The near-term fate of debt-strapped Greece, Spain, Italy, and Portugal and the impact of their fragile condition on the regional, and even global, banking system is not yet clear.
But some asset allocation advisers and fund managers believe there is a place for European exposure in a diverse portfolio that can tolerate at least some level of risk, particularly if investors look past the current situation and focus on company fundamentals and valuation.
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Select European multinational companies, like their U.S. brethren, stand to benefit from emerging market demand for their goods and services. Emerging markets are expected to lead this global recovery, outshining the established economies that remain bogged down by debt as well as consumer and business spending hesitation.
Analysts aren't ignoring Europe's troubles, but they find a different story in the details. Even the Greek situation, as risky as it seems currently, is likely to be handled in a controlled way. That's particularly true given the lessons learned from the Lehman Brothers failure and ensuing 2008 credit crisis, says Jonathan Bergman, certified financial planner and vice president at Palisades Hudson Financial Group in Scarsdale, N.Y. He expects an orderly restructuring for Greek debt, which he admits might include an actual default.
"Financial markets fear a domino effect, in which there's a 10-domino lineup, with the first domino Greece and the 10th domino a global depression," Bergman says. "It's true that it takes a bit of chaos to get government leadership to act, but they will act—before the 10th domino falls. The market is trading as if we're already past the fourth or fifth domino; we're not there yet."
Focus remains on limiting the spread of certain European Union member debt burdens throughout the banking system. The Financial Times reported in early October that European Union finance ministers are examining ways to coordinate recapitalizations of financial institutions after agreeing that additional measures are needed.
There has been some disagreement over the level of help that should be given to countries that have run up steep debt tabs; Greek's austerity measures have fallen short of the expectations among some of its regional peers.
Germany, the strongest eurozone member financially, has a powerful incentive to stay in the group, Bergman points out. The relative weakness of the euro due to weaker eurozone economies has helped make Germany, with just 82 million people, the world's second largest exporter, behind China and ahead of the United States. If Germany still had its own currency, its relative strength would hurt exports. It's an argument that has political implications for officials trying to soothe a public upset that they are shouldering the responsibility for Greece's spending extravagance.
It's that export story that leaves Bergman optimistic. He advises putting 40 percent of an international equity portfolio in Europe—a bit less than most international indices allocate to Europe. Since his firm recommends allocating 35 percent to foreign stocks, that equals 14 percent of total equities in Europe.
Put 70 percent of your European investments in a large-cap European index fund or ETF, he says. That will bring exposure to multinational powerhouses like Royal Dutch Shell, Nestle, Roche and GlaxoSmithKline, to name a few.
Investors should consider adding a slim percentage of small-cap companies, but focus on those with strong exports outside of the European continent. With small caps, active management adds enough value to make it worth the management fee, Bergman says.