Europe changes gear

European equity markets offer a number of potential attractions over other developed markets at this point in the investment cycle; not least of these is the relatively robust health of Europe's consumers.

Over the past decade, cultural factors have led mainland European households to be much more prudent than either their US or UK counterparts. For example, while the average German has been saving around 12% of their salary each year, the average American has been spending in excess of what they earn each year.

Another attraction is that large European companies generally benefit from a far greater geographic diversity in their revenue streams than those in the UK or US. This is because, faced with limited growth opportunities at home, European companies have spent the past 20 years or more expanding into growing overseas markets.

The result is a new breed of large European company, which competes globally and which offers the prospects of strong and sustainable earnings. This can be seen from the fact that Europe now broadly exports as much to Brazil, Russia, India and China as it does to the US, while central and Eastern Europe also account for a similar slice of the export pie.

While Europe and the eurozone in particular are at the centre of the government debt crisis, and the euro has weakened, there are a number of exporters which have materially benefited from this weakness in the currency. So whatever is happening in Europe or elsewhere, there will always be significant investment opportunities, as Europe contains some of the world's best companies, stoking the furnace of world growth with their intellectual, financial and physical capital.

Meanwhile, European equity valuations look genuinely compelling, and in many cases there is an excellent buying opportunity in companies boasting strong balance sheets and sustainable cash flows.

Although Europe may not yet be regarded as a traditional source for high levels of equity income, this is likely to change. The income universe in Europe has a great number of diverse companies to choose from. As at 1st July 2010 there were 430 companies in continental Europe yielding more than 3% with a capitalisation greater than €500m. This compares to 100 in the UK¹!

Elsewhere, social and cultural changes within Europe's shareholder base also continue to exert a strong influence on the level of European dividends. A key factor is that Europe's population is now one of the oldest on earth.

By 2015 it is estimated that one in three Europeans will be over 65 years of age and, with an ever greater proportion in retirement, life expectancy continuing to rise and interest rates still declining, there is huge investor demand at a grass roots level for income generating investments in Europe.

Another cultural change has taken place within European companies themselves. European company managements are increasingly becoming shareholders in their own right, and this has helped to foster the continued development of a European dividend culture.

It's important not to focus just on those companies that offer a high level of dividend yield (ie the dividend expressed as a percentage of the share price) because a high dividend yield can be an indication of a company that is experiencing difficulties. A company could be experiencing business problems causing its stock share price to fall and the dividend yield to rise. The key is to find companies that pay a high level of dividend which can be comfortably sustained over the longer term.

In terms of dividends, leading European companies include the oil major Total, which has a strong record of raising its dividends in recent years. Other more defensive areas of Europe's stock market which currently offer very attractive levels of yield include the likes of the German postal monopoly Deutsche Post, and the food giant Nestle.

The Newton European Higher Income Fund employs the same sort of strict yield criteria as the flagship Newton Higher Income Fund. It's partly this consistency of approach and objective that has helped the Newton Higher Income Fund to grow well past £2 billion in size today. Investing in equity income funds, such as the Newton Higher Income Fund, is not without risks, however, as funds of this type are invested in shares and so investors' capital is not guaranteed. When you sell your investment you may get back less than you originally invested./

In the case of the Newton European Higher Income Fund, the yield discipline requires that any company share considered for the portfolio must yield 15% more than the yield on its national market index. When the yield on a portfolio holding declines to be in line with its home index, the shares are sold and the proceeds reinvested into the most attractive new investment ideas generated by Newton's team of professional company analysts.

By applying Newton's thematic approach alongside its yield discipline, the Newton European Higher Income Fund offers UK investors the opportunity to diversify their income investments right across European markets.

It also offers those with existing investments in European companies the opportunity to reduce the investment risk in their portfolios as equity income investment generally tends to be far more defensive in nature than investing purely for growth. With interest rates in the western world already at historic lows, this approach to investment can only increase in importance.

Investing in equity income funds may not meet all investment objectives. If you are unsure which type of investment is right for you, then you should discuss your particular financial needs with an Independent Financial Adviser.

When investing, it is important to understand that all investments carry a degree of risk - some more than others. Here we explain the nature of risk in investing and introduce the risk & return ratings for BNY Mellon Investment Funds. These include indicators of the suitability of our funds for different types of investors.

¹ Source: Datastream as at 30th September 2010.