An update on the Euro

An update on the euro
By Marc H. Brillon and Rupert Tate

The international financial community began the year with a "business as usual" approach, following the major conversion exercise resulting from the introduction of the euro, Europe's new single currency. Many commentators had doubted the ability of financial institutions to convert the vast array of asset, portfolio and client data from the old legacy currencies to euros over the three-day New Year, but this was achieved on time to allow the smooth entry of the euro into the global financial system.

The questions that fund managers are therefore asking themselves are what is going to be the ongoing and long-term impact of the euro on economic trends and market movements and what is the potential for Europe to match the United States in its level of financial development.


Fund managers have had two years of booming corporate activity to get used to the role that mergers and acquisitions have played in the performance of European stock markets. In the last quarter of 1998 alone, $116 billion of M&A activity took place, dwarfing the $67 billion in the first three quarters.

Price transparency in labour and product markets is continuing to force corporations to radically rethink their business strategies and competition, restructuring, rationalisation, and relocation continue to be top of the agenda across European boardrooms. As companies position themselves to access business opportunities across the entire economic block, the M&A trend could reasonably be expected to continue. But it is hardly new. The spotlight may now move from companies to investors as Europeans broaden their investment horizons beyond national frontiers.


As domestic marketplaces have been redefined for companies, domestic investment universes have been redefined for savers. Not only are equities now more attractive relative to bonds with lower bond yields, but the domestic investment opportunities available to Europeans are much broader than those offered within any one individual market. Spaniards could not gain access to pharmaceuticals stocks in Spain, while Germans could not buy shares in oil majors in Germany. This has now changed decisively. Europeans are now offered, with no currency risk, a broader range of investment opportunities in which--and with the link up of European exchanges--they are likely to be able to deal more cheaply. Market regulation is also better and information more readily available.

This trend of diversifying holdings in a single market out across the eurozone should favour large cap stocks as investors initially concentrate on household names they are familiar with, and for which information is readily available. This was one of the most striking features of the first day of trading in euros. Blue chip stocks outperformed dramatically. There are currently 28 stocks that appear in all European indices. There is likely to continue to be strong demand for these shares. If fund managers do not own these shares, they will need to have clear reasons for not doing so.


As investors broaden their benchmarks, competition in the fund management industry will intensify. European equity mutual funds pre-EMU concentrated largely on domestic markets and without an equity culture, management of these funds in most markets was dominated by domestic players. Few markets offered the potential for an overseas player to capture sufficient market share to justify a local presence.

This is now likely to change. Not only has the potential demand for European equity products grown, but many of the existing players in a number of markets do not have the required expertise or resources to develop a range of European products. For fund managers with the resources to deliver the right products, the potential rewards will be considerable.

Fund managers will be playing for bigger rewards in the years ahead as demand for investment products grows, but as clients become more demanding, they will also be playing with bigger chips. Effective investment across Europe requires an in depth understanding not just of local markets, but of industries on a pan-European basis.This is labour intensive and requires substantial investment in people and systems. To produce consistent performance it also requires a clearly articulated and disciplined investment process, together with investment in the development of products that are structured in such a way that they can be marketed across Europe.


For bonds, the ability to add value through intra-European currency management will be eliminated by the introduction of the single currency in the eurozone. The key driver for bond valuations within the eurozone will be the changing role of government involvement and ownership changes in the structure of industries.This will produce opportunities for bond investors as governments withdraw support and these institutions stand alone, issuing bonds in their own name with varying degrees of government support.

EMU should increase the attractiveness of corporate bonds for both the issuer and the investor as a single currency will allow corporations in one EMU country to have access to capital markets of another. Managers will focus their added-value strategies on credit diversity and credit analysis. In addition, markets for asset- backed securities, mortgage-backed securities and euro-denominated bearer securities are expected to develop.


The euro is expected to rapidly drive the harmonization of outstanding tax and regulatory issues. The financial impact of changing demographics is already having a substantial effect on state welfare schemes and the move towards privately funded systems is focusing the debate on the legislative, regulatory and market implications from the shift of funds from state to private sources. This should all work in the favour of stimulating access to investment opportunities across Europe.

The euro / dollar relationship is a key consideration for the non-eurozone investor. The early signs are that the European Central Bank has established its credibility and that external investors have taken to the new currency. A recent Merrill Lynch survey of fund managers around the world highlighted the belief that the euro will be stronger than either the dollar or the yen in its first year and will benefit equity and bond markets in the eurozone.

The advent of the euro has therefore effectively created one European market for savings products and a range of investment vehicles have been launched to satisfy investor appetite in this target market. For Canadian investors, the decision will be to weigh up potential returns from existing investment markets against the returns from the European marketplace, factoring in the exchange movement of the euro against competing currencies. n


Marc H. Brillon and Rupert Tate are directors, Merrill Lynch Mercury Asset Management. Mr. Brillon is in Montreal, Mr. Tate is in London

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