Europe & Its Standout Countries

U.S. investors don’t pay a lot of attention to Europe. The continent pops up on investors’ radars every few years—usually when something bad is happening, like the eurozone sovereign debt crisis of the early 2010s or the Brexit saga of a few years ago. Other than those examples, there’s not much talk about Europe by investors.

There are reasons for that. The most obvious is home country bias; people strongly prefer to invest in stocks of companies in their own country. But there’s also the narrative that Europe is a slow-growing region with a lack of innovative firms.

To some extent, this narrative is true. Between 2010 and 2020, GDP growth for the European Union averaged 0.9% per year—nearly half the growth rate of the U.S. economy in the same period.

There’s also been a distinct lack of big tech companies in Europe, a category that’s powered innovation in the U.S. and fueled the country’s stock market to incredible gains.

In fact, of the 20 largest publicly traded companies in the world, only one is European—LVMH, a French luxury goods conglomerate. And if you look at the Vanguard FTSE Europe ETF (VGK), the largest Europe-focused ETF in the U.S., with $21.6 billion in assets under management, less than 10% of its portfolio is in technology stocks.

It’s no surprise then that U.S. investors aren’t flocking to invest in Europe, with the 71 Europe-focused equity ETFs listed in the U.S. having combined assets of only $70.2 billion—not a lot in the context of a $7.1 trillion U.S. ETF market.

Startup Hot Spot
But even if Europe’s staid reputation has been warranted up until now, things are rapidly changing. A combination of cloud computing, abundant capital and the work-from-anywhere phenomenon has sparked a boom in funding for European startups.

Venture capitalists are on track to allocate more than $100 billion to European firms this year, according to Crunchbase, nearly a fifth of all VC funding globally.

Some of these startups will likely grow to become powerful tech companies, eventually landing in the public markets and fueling returns for anyone invested in European ETFs.

At least that’s the bull case. Because Europe hasn’t produced many tech giants in recent years, it takes some imagination to believe that could change in the coming years. But it’s absolutely a possibility, and we’ve actually seen it before. Look no further than China to see a stagnant economy turbocharged by a robust tech industry.

Semiconductor Powerhouse
It’s also important to note that Europe is no monolith. There’s a big dispersion in the outlook for certain European countries versus others.

The Netherlands, for instance, has become something of a semiconductor powerhouse thanks to Dutch company ASML, a $300 billion giant, and one of the most important technology companies in the world. ASML’s lithography machines are essential to the manufacturing of the most-cutting-edge chips used in everything from iPhones to computers running artificial intelligence algorithms.

Adyen, a Dutch payments company, is a big tech winner from the Netherlands. Today the company processes payments for eBay, a role the firm stole from U.S. payments juggernaut PayPal.

Unsurprisingly, the iShares MSCI Netherlands ETF (EWN) is the second-best-performing U.S.-listed European ETF over the past five years, with an 18.1% compound annual growth rate. EWN’s 39% weighting in tech—22% in ASML alone—has certainly juiced its returns.

The only Europe-focused ETF to beat it over the past five years is the iShares MSCI Denmark ETF (EDEN), with an 18.9% CAGR in the period.

The Denmark ETF took a completely different path to outperformance, with only 2% of its portfolio allocated to technology. Instead, the Denmark portfolio is heavy on health care stocks, which make up 39% of the fund. Danish pharma giant Novo Nordisk alone makes up a quarter of the ETF, and has more than tripled over the past five years.

Financials Weigh
It’s some of the smaller, industrious European countries that have seen the greatest outperformance in their stocks over the past several years. As in the case of the Netherlands and Denmark, these portfolios can tilt quite heavily toward a single stock or a handful of stocks.

When those stocks are working, that can be a boon. But when they’re not, it can be a real drag. For instance, the big banks that make up nearly a third of the iShares MSCI Spain ETF (EWP) are a large part of why the fund has lagged so much over the past five years, delivering a CAGR of only 3.6%.

It’s the same for the Global X MSCI Greece ETF (GREK). Financials have weighed heavily on the fund, leading to only a 3.8% CAGR over the past five years.

Factors To Consider
What’s clear is that sector allocations are an important determinant in ETF performance, and those allocations can vary widely from country to country. Tech has outperformed significantly in recent years. That may not always be the case, but what will likely be the case is that the most innovative companies will tend to come from technology, biotech and adjacent industries.

Especially in today’s fast-changing, digital world, companies need the best technology if they want to compete.

Tech stocks have tended to be the most innovative, but there’s also the argument espoused by some that old-school industries and value stocks will come back in vogue. If that’s your thesis, then perhaps some of the financials-heavy or industrials-heavy European markets are a better option for you.

In any case, looking under the ETF hood is a must when wading into the single-country ETF pool.

In addition to analyzing sector allocations and individual holdings, zoom out and take a look at the macro picture as well. GDP growth rates, demographics and startup funding all paint a picture of the growth potential of a given country.

Europe is not a monolith, and it could be time for U.S. investors to start paying more attention to stocks across the pond.