Portfolio Manager
European equities are firmly back on investors’ radar screens. Since the beginning of 2025 to March 2026, European equity funds received over €74 billion in net inflows, which is the strongest demand we’ve seen in a decade.
What matters isn’t just that money is flowing back, it’s why. It’s happening because investors are looking for alternatives to expensive, concentrated equity exposure elsewhere, and they’re looking for return drivers that aren’t all the same trade.
Europe is indeed gaining attention from investors thanks to its reasonable valuations, broad sector mix and differentiated return profile – all of which are supported by an improving outlook for the European economy and corporate profits. With concerns over concentration in global equity portfolios rising, we think the balance of evidence favours a structural shift in allocations towards Europe.
Risks remain, hence the attractive valuation. There is uncertainty over the impact of the Middle East conflict, trade pressures and currency volatility all needing to be monitored. These risks reinforce the importance of partnering with experienced active managers that have the ability to uncover mispriced opportunities and generate excess returns across the market cycle.
Europe’s economic outlook is transformed
Europe’s former economic headwinds are becoming tailwinds. After years of austerity and over-regulation, European governments are starting to loosen the purse strings and boost spending, while they are also increasingly moving to a pro-growth regulatory stance. The result is an improving outlook for the economy and an upgrade to corporate profit expectations.
Most notably, the fiscal backdrop has been transformed, as Europe moves into a sustained period of fiscal expansion that should support domestic demand. Over the last 18 months we’ve seen the announcement of wide-reaching European Union recovery initiatives, and the unveiling of Germany’s much-heralded fiscal stimulus package (which stands to reach around 12% of GDP), as well as broader rearmament and infrastructure packages.
While Europe’s fiscal rules have been turned on their head, the regulatory environment has also spun 180 degrees. Competitiveness is now the focus for regulations, guided by the blueprint published by former ECB president Mario Draghi in late 2024, which marked a change towards more pragmatic, flexible and growth-oriented policies. We can observe this in the telecommunication market in the Nordics for example, where consolidation should help improve margins, but also in the auto sector where the EU 2035 target has been revised to allow up to 10% of new cars to use combustion engines beyond 2035.
This backdrop will help corporate earnings to grow. Our internal analyst team is projecting a healthy 11% total European earnings growth in 2026 and we’ve seen analysts upgrading their numbers since the beginning of the year. It’s true that a significant portion of the upgrade is coming from the energy sector. But we’re also seeing forecasts improve across a range of other sectors including capital goods, utilities, semiconductors and banks, proof that the upgrade cycle has real breadth behind it. There are multiple medium-term tailwinds – fiscal stimulus, AI buildout and resilient credit conditions – helping to drive growth in 2026 and the years ahead.
Valuation still matters
European equities trade at a valuation discount to the US across most sectors. This is nothing new and can be explained by multiple factors. More importantly in Europe, valuations are also not stretched on an absolute basis, with the MSCI Europe Index trading at roughly 14.9x on a forward price-to-earnings( P/E) basis (as of 25 June 2026), in line with historical averages.
And in the long term, valuation matters: the price you pay today determines your long term return. Historically, buying the market at this valuation point has delivered attractive long-term returns.
Stronger growth is also the key to narrowing the valuation gap to the US. As Europe pivots from austerity to investment, higher defence and infrastructure spending – plus targeted industrial support – should sustain capital formation and employment, support elevated merger and acquisition activity to crystallise value in listed names, and boost domestic demand.
We don’t expect Europe’s long‑standing discount to disappear entirely. The gap in valuations reflects long-term growth, profitability and return expectations as well as Europe’s recent economic challenges. But we do feel that a compression in the discount is realistic, driven by better earnings visibility, a healthier balance between policy and growth, and a re-rating in areas where the disconnect from fundamentals is widest.
Europe offers a diversified exposure
As well as offering a valuation advantage, European markets provide the opportunity to diversify across a broad mix of sectors. In a world where global equity benchmarks are dominated by a small number of tech and AI-related companies, diversification has become essential for capturing returns and managing risk in portfolios. Compared to the US, Europe’s lower index-level concentration and broader sector mix creates more opportunities for active managers to manage risk and express their views.
Europe’s banking sector has been a major driver of returns. Europe’s banks have spent several years resetting cost bases, while positive interest rates have restored profitability and capital generation. Over the last five years, the sector has outperformed the US Magnificent Seven stocks, yet valuations are still supportive, with several lenders trading at modest multiples while maintaining disciplined capital returns. In the sector we’re finding opportunities in UniCredit in Italy and AIB in Ireland, which are both benefiting from their cleaner balance sheets, improving cost efficiency and shareholder-friendly distributions.
Investors can find well managed European utilities and power producers with attractive cash yields that are well positioned for an increasingly variable grid. We’ve found attractive opportunities in companies that have growth optionality, such as exposure to their flexible generation capacity, which is particularly valuable as the contribution from renewables increases. For example France’s Engie, which trades on an attractive valuation, is focused on shareholder value, and is expected to benefit from grid investment, power demand growth from data centres.
The move to a lower carbon economy is also driving growth in Europe’s industrials and engineering sector, where companies are positioning themselves to benefit from Europe’s electrification and grid modernisation themes. Investment commitments from governments in new energy infrastructure are starting to show in earnings forecasts as project planning converts to execution. Germany remains the bellwether, but across Europe substantial infrastructure and industrial investment is creating multi‑year order books. Beneficiaries include SPIE in France and Bilfinger in Germany.
Another key beneficiary of government spending is Europe’s defence sector. European defence budgets are rising, translating into longer order books and a more durable demand cycle. And when it comes to defence spending, domestic exposure can be an advantage as procurement often favours local champions. For example, Indra Sistemas in Spain, which is attractive given the potential for a multi-year upgrade cycle as Spain catches up with its NATO spending commitments.
Even in Europe’s large consumer-related sectors, where weak headline consumption data has been a headwind in recent years, the underlying signals are now improving as lower interest rates and pockets of excess savings drive demand.
Europe offers lower correlations to global equity benchmarks
Europe’s differentiated sector weightings, combined with geopolitics-driven fiscal spending, result in lower correlations to US growth benchmarks, strengthening Europe’s role as a diversifier in global portfolios. These differences in the sector and policy mix mean European markets tend to look and behave differently to other regions, which is increasingly valuable as investors seek genuine diversification and resilience in their global equity allocations across macro regimes.
Crucially, Europe is much less directly exposed to the AI investment boom than the US, Japan and emerging markets, where benchmarks are now AI‑heavy. Instead of spending huge sums to build leadership positions in supercomputers or consumer AI, European companies are set up to make money where AI meets the real world: power and grid equipment, high‑voltage and power conversion, factory automation and robots, simple software that links machines with computers, and analog/power chips used in cars and industry. These are the areas that matter when AI needs more electricity, steadier grids, and clean links into production lines.
This is a good setup for Europe. If AI disappoints, Europe will be less impacted because it has fewer pure‑AI companies in its benchmarks. But if AI is the real deal, Europe should still gain as companies upgrade power systems, digitise grids, automate factories, and roll out practical software with a high return on investment – all without needing “frontier model” valuations. When you add in the expected rise in government spending, Europe stands out as one of the few big equity regions with a growth story that doesn’t depend on AI, yet it can still benefit if AI proves transformative.
As a result, we believe Europe’s performance drivers can complement US exposure in global portfolios, while also providing more effective diversification than emerging markets now that many emerging market indices are dominated by AI names.
Conclusion: Active stock picking is key to unlocking Europe’s full return potential
We believe a structural shift back into European equities is underway as investors look to diversify their exposure to concentrated, tech-dominated US and global benchmarks. But the move back to Europe isn’t just a diversification play. The case for investing in Europe is also supported by an improving long-term outlook for regional growth, relatively attractive valuations and a broad range of stock-level opportunities across a wide range of sectors.
There is also a potential upside surprise, as investors may be underestimating the extent to which European earnings and sentiment could improve if the backdrop becomes even modestly more positive. A market that offers access to an attractive mix of fiscal and monetary settings, a more pragmatic/pro-growth policy stance, and more pricing dispersion than heavily crowded exposures elsewhere provides opportunities for active stock pickers to identify mispriced winners. As a result, allocating to European equities with an experienced active manager can help investors to diversify their broad market exposure while providing the potential to generate returns above the market through active stock selection.