What’s needed for Europe’s investment renaissance?

Why Europe has lagged

After growing healthily in the 1990s and early 2000s, Europe’s economy was hit hard by the global financial crisis (GFC). Since then, growth has been rather lackluster relative to the U.S. That’s partly because Europe has been hit by a series of shocks – like 2011’s sovereign debt crisis and Russia’s invasion of Ukraine that drove up energy prices.

But at the core of the region’s weak growth are several structural challenges. GDP per capita in the EU has lagged that in the U.S. Around 70% of that gap is down to weaker productivity growth, mainly because lower-growth industries – like manufacturing and banking – make up a greater share of the EU economy, while the fast-growing tech sector is a bigger chunk of the U.S. economy.

Tighter fiscal and monetary policy, red tape and heavy regulation, along with a shrinking workforce are all factors also hindering Europe. 

That’s seen European corporate earnings lag the U.S. since 2008 and linger below their pre-GFC peak. 

Europe steps up reform efforts

A relatively stable world, cheap energy from Russia and a workforce boosted by immigration and higher female participation reduced the sense of urgency around addressing Europe’s long-held challenges. But recent developments restored a sense of urgency: Russia’s invasion of Ukraine, weakened NATO guarantees and rising protectionism have jolted Europe into action.

In June, NATO members agreed to target defense spending of 5% of GDP by 2035, up from the previous 2% target that was long undershot.

Another area we see urgency driving tangible progress? Energy. Power prices in the EU are more than double those in the U.S. and China and it’s heavily reliant on imports, making the bloc vulnerable to external forces and geopolitical risks. That’s spurred the European Commission to present a comprehensive Action Plan for Affordable Energy that aims to promote competition and reduce lengthy permitting times. Between 2020 and 2022, the average time to commission wind energy projects in Europe was over four years – versus three in China and less than two in the U.S.

Favoring a selective approach

We think investing in Europe is still – for now – mainly about finding selective opportunities driven by the increasingly pro-growth agenda.

One example is in defense, where we see hefty government spending plans potentially yielding opportunities in defense tech. That’s not just AI and software companies, but also IT services and hardware like semiconductors that enable advanced technologies.

We also see near-term opportunities in EU banks, insurers and asset managers as we expect them to be conduits of rising public spending on infrastructure and defense. We see interest rates staying positive and expect steeper yield curves compared with pre-pandemic – supporting net interest margins for banks. European banks have delivered higher average returns on shareholder capital than U.S. banks.

Within private markets, we like private equity in advanced manufacturing and automation, as well as infrastructure funds focused on industrial retrofitting, energy systems and logistics. Infrastructure is now the second-largest asset class for private capital in Europe, according to Preqin, with total assets under management exceeding €600 billion and growing at the fastest rate over the last five years compared to other regions.