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28/09/2021

The Future of Investment in Europe

Economy Europe

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Milo Rignell

Fellow - AI & Emerging Technologies

Investing in Europe

Europe is trying to revive its economy following the Covid-19 crisis by insisting on resilience and investment in the future, with digitalization and climate change leading the charge. More than ever, its autonomy with respect to the United States and China, in a context of growing geopolitical tensions, as well as the development of a model of responsible capitalism specific to Europe, depend on its ability to finance and refinance its economy, its companies and its regions.

In order to address these issues, Institut Montaigne and Sciences Po’s School of Management and Innovation have decided to launch a cycle of events on the future of investment in Europe. This article follows the first event on the place of Europe in the world as an investment opportunity, with Gabriel Caillaux, co-President, Managing Director and Head of EMEA at General Atlantic, Hélène Rey, Professor of Economics at the London Business School, Michael Thawley, Vice President of Capital Group International, and Natacha Valla, economist and Dean of Sciences Po’s School of Management and Innovation.

Europe has what it takes

Europe presents just as much potential for finding attractive companies as any other market, with strong levels of innovation and entrepreneurship providing significant opportunities for outsized returns. Accompanied by functioning capital markets, real respect for the rule of law, a liquid currency and its position as one of the world’s largest economic regions, Europe remains a market that investors want exposure to. This combination of stability, security, and innovation constitute Europe’s main potential as an investment opportunity.

However, although the European private equity market has overall matured over the last few years, venture capital still suffers from the absence of large, European actors, leaving space for American firms to fill the gap. Public markets also remain less attractive to European companies when choosing where to list, due to lower levels of specialization among EU fund-managers, and stringent listing requirements.

A cyclical market tied to macroeconomic trends

Many European companies are global exporters with high exposure to the world economy, which enhances their attractiveness but also deepens their dependency on other countries’ performances.

Europe might be reaching a point of stabilization rather than continued growth.

In the short-term, despite strong fiscal stimulus and the ‘Next Generation EU’ economic recovery program, Europe might be reaching a point of stabilization rather than continued growth, with supply-chain difficulties lasting longer than anticipated and slowing growth of the money supply.

Central banks’ monetary policies will indeed continue to have a decisive role in shaping the continent’s attractiveness for investors. The actions of the United States’ Federal Reserve System have for instance fueled risky asset pricing, while the impact of the People’s Bank of China has been mostly limited to trade and commodities. The actions of the European Central Bank sit somewhere in between. Furthermore, central banks’ reactions to inflationary pressures will be critical in shaping the future of investment in Europe, and while the Covid-19 pandemic has prolonged low real interest rates, the return of higher rates remains a real possibility.

Unexpected policy decisions driving investor uncertainty

Europe has historically been perceived as an overall stable and predictable market. Europe’s MSCI-EMU index has even recently been outperforming its American counterpart, due in large part to its relatively successful handling of the Covid-19 crisis and high vaccination rates.

This perception of stability needs to persist. However, unexpected policy decisions and changes in the broader environment have heightened uncertainty for investors. Brexit, for instance, caused a significant pause on flows of capital into private companies in Europe.

Today, attitudes towards the finance sector appear to be worsening. In most European countries, skepticism is growing, with rising criticism that the finance sector has been consuming too many human resources.

Attitudes towards capital allocation seem to be changing, too. It is becoming increasingly clear that governments hold strong views on the allocation of capital, in particular to areas like ESG and climate change. While investors are incentivized to follow governments’ lead, they also find themselves increasingly exposed to bubble effects and sudden shifts in policy, amongst other risks. Attitudes towards foreign investment further complicates Europe’s ability to attract investors.

In most European countries, skepticism is growing, with rising criticism that the finance sector has been consuming too many human resources.

New foreign investment screening rules are often applied indiscriminately, including to long-term, passive investors that should be particularly attractive to governments. This heightens governments’ exposure to less desirable types of investors.

Finally, a major concern revolves around investment in bonds in Europe, which directly depends on investors’ confidence in the European Central Bank continuing to do "whatever it takes" to support the system. Any level of doubt would be deeply detrimental to Europe’s ability to attract foreign investment.

Making Europe attractive

Deepening European financial integration, in particular by completing the banking union and capital markets union, is key to dealing with the differences in growth rates between the various member states - one of the fundamental contradictions lying at the foundation of the eurozone.

Working on the resiliency of the European economy will also be key to avoiding problems if interest rates were to rise.

Europe must work to improve the governance of its resource allocation to developing human capital, in order to credibly rival foreign institutions such as Stanford and MIT.

Finally, it is important to also consider making Europe more attractive to companies, and not only to investors. Simplifying the listing rules for growth companies that need to access capital in Europe would be a good starting point.

If these conditions were united, the EU might be able to greatly surpass the 13.5% share of global market capitalization that it currently represents and attract the necessary investment to fund the economy’s transformations.

Co-authored with Elise Lannaud, Assistant Policy Officer.

Copyright: Yann Schreiber / AFP

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