Personal Finance: Placing trust in Euroland

European trust funds can be very profitable, but investors should tread with care.

THERE ARE plenty of reasons to wonder if European equity markets are at the end of a long bull run. Of course, the sector still looks tempting if you measure unit trust performance over five years or more .

On this time scale, the FT/Standard & Poor's European index of share values shows an increase of 115.9 per cent, almost identical to the 115.96 per cent chalked up by the UK All Share index to the end of May.

"This has been an easy environment for fund managers to do well in," argues Lesley Ann Hodges, the associate director of research at Standard & Poor, "as long as these underlying indexes continued to grow in value."

But over the last 12 months, the same European Index has shown growth of just 0.63 per cent. This compares to the FTSE All Share's 5.01 per cent growth and 20.82 per cent growth from the USA's top 500 company shares.

Of the European sector's top 15 unit trusts measured by five-year performance, only eight have managed any positive return at all over the last 12 months. With some 143 trusts in the sector as a whole, two thirds have fallen in value over the same period.

The message here is one of short-term volatility after a period of explosive growth. "What goes up, usually also comes down," warns Ms Hodges, "and the big question is always by how much."

It would also be a mistake to assume that simply because any two unit trusts fall within the same European sector they bear much resemblance to each other in terms of asset allocation, management style or charges.

The definition of a European trust is wide; at least 80 per cent of assets must be in Europe, including the UK, although UK assets must not exceed 80 per cent of the total. This leaves plenty of choice; try comparing pan-continental, and "Euroland" trusts.

Pan-continental trusts invest across the whole of Western and Central Europe, including "side economies" like Sweden and Greece. Some will take positions in the so-called "new economies" of Eastern Europe, typically Hungary and the Czech Republic. Most importantly, they include Switzerland, home of several of the world's largest pharmaceutical and insurance companies.

Euroland - by contrast, includes only EU countries, signed up to benefit from European Monetary Union (EMU). Aside from the UK their natural focus is on the so-called "core economies" of Germany, Italy and France.

Most of these trusts hold shares only in large companies, known as large- caps. But some funds specialise in small and medium cap shares.

Next comes exposure to fast growing venture capital markets. For instance, the German Neue Markt, founded two years ago, has created a new market for shares in fast growing, risky enterprises. This can bring big profits but is deemed too risky by Daniele Serruya, who manages the European Smaller Companies unit trust at Schroder, a large fund management firm.

"It is often too early to say which of these very new companies will survive but fund managers are relying on taking risks in this type of investment to push up their results."

Rory Powe, a fund manager at Invesco GT's European Growth unit trust, disagrees: "There is still huge growth in these venture capital markets, driven by the sclerotic nature of so many large German firms. Real change, real innovation often has to come from outside the established corporate structure."

All of this makes it harder rather than easier to pick a European trust that should do well; the reality is that the sector straddles a number of different investment philosophies and widely varying asset allocations.

Some fund managers are highly individualistic in their approach. Examples here include Fidelity's Anthony Bolton, with a reputation already established through managing its UK Special Situations trust.

Other, like Mercury, see fund management as a team activity, deliberative, consensual, and working within strictly defined guidelines.

Ms Hodges warns: "Many of these trust managers are too index aware; more or less reproducing the asset allocation of their chosen index. Typically, these trusts will be slow to move, following the markets, and very overweight in large cap shares."

Part of the reason for this is that fund managers are nervous of the way passively-managed index funds have taken so much of our money. This is part of a larger cultural change; managers are now expected to measure their performance relative to benchmarks which are in turn based more or less directly on share indexes.

Guillaume Rambourg, a fund manager at Gartmore, thinks that there is room to combine both approaches in one unified fund. "Avoid either too much exposure to large or small cap shares, and choose a generalist fund with a pan-European remit."

"Before investing get yourself some trust prospectuses and do you homework," warns Ms Hodges, "Check up on factors like the number of different shares that are held, the industry sectors they belong to, and the stated goals of the fund managers."