Traders seek refuge in Europe's large-cap stocks

Mon May 12, 2014 6:26am EDT

* Large-caps offer shelter in uncertain market environment

* M.Stanley team backs large-caps over smaller stocks

* M&A activity centred in large-cap sector over last month

* ETF data shows flows moving into large-caps

By Sudip Kar-Gupta

LONDON, May 12 (Reuters) - Investors are targeting European large-cap stocks, lured by attractive valuations and the refuge they can offer from volatility stemming from such concerns as the Ukraine crisis.

The move is likely to herald a change in attitude among investors since mid- and small-cap shares have been outperforming their larger peers on expectations of an improving stock market environment.

This could be good news for large-cap stocks such as French oil major Total, U.K. telecoms group Vodafone and German bank Commerzbank, which are currently trading at a relatively low valuation.

Anxiety over a slump in emerging markets and clashes in Ukraine between the authorities and pro-Moscow protesters have created an uncertain geopolitical climate which has seen the pan-European FTSEurofirst 300 index zig-zag between lows of 1,263 points and highs of 1,359 points so far this year.

"I am concerned by the Ukraine situation. I think large-caps will protect you more on the downside as they are more liquid," said Emanuel Arbib, head of London-based Integrated Asset Management.

Morgan Stanley's European equity strategists this month also backed large-cap stocks - often considered as those with a market capitalisation of more than $5-10 billion - over mid- and small-cap stocks.

"After years of underperformance, we believe now is the time to raise exposure to large-cap stocks as they offer the best risk-reward across the market, in our opinion," said Morgan Stanley strategist Graham Secker.

Secker highlighted relatively attractive valuations for Europe's biggest stocks, with Thomson Reuters Datastream showing that the price-to-book ratio of MSCI Europe large-cap stocks stands at just under 1.5 - below a price-to-book ratio of just over 2.0 for MSCI Europe mid-cap stocks.

MERGERS BOOST

When the stock market rises sharply, investors often favour small and mid-cap stocks as they can surge in value more quickly than their larger peers, such as during the 1999 Internet boom.

The MSCI Europe Mid Cap Index rose 30 percent in 2013, beating a 20 percent rise on the MSCI Europe Large Cap Index.

However, when investors are more uncertain about the near-term market environment, they can favour large-cap stocks due to the protection they offer in terms of large profits, solid cash-flow and chunky dividend payouts.

Volatility on the MSCI Europe Large Cap Index, as measured by annualised standard deviation, came in at 2.2 percent over the last 12 months, compared to 10.3 percent on the mid-cap index, according to data from MSCI's website.

ETFGI, a research and consultancy firm covering the ETF (exchange-traded fund) and ETP (exchange-traded products) industry, said April saw inflows of $515 million into ETFs and ETPs covering European large-cap stocks, compared to outflows of $93 million for those covering European small-cap stocks.

Large-cap stocks have had a further boost in the last month since much of Europe's merger and acquisition activity has been concentrated in that sector rather than among smaller firms.

French manufacturing group Alstom faces bid interest from GE and German peer Siemens, while UK drugmaker AstraZeneca is being targeted in a possible $100 billion-plus bid from U.S. peer Pfizer.

Morgan Stanley's top picks among European large-cap stocks included pharmaceutical group Shire, which has also been a focus of takeover speculation, and UK telecoms operator Vodafone, which has been the subject of possible bid interest from U.S. peer AT&T.

"We believe this higher level of activity could help unlock the value in European equities - particularly in the large cap market in which a lot of value has been evident but that has remained untapped to date," said Andrew Arbuthnott, head of European large-cap equities at Pioneer Investments. (Additional reporting by Vikram Subhedar; Editing by Francesco Canepa, Lionel Laurent and Gareth Jones)

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