Finding nooks of growth in a sluggish Europe

By John Wasik

CHICAGO (Reuters) - While the euro zone presents the unalluring face of sluggish growth, that doesn't mean it should be neglected. There are pockets of promise that are worth exploring.

The reason for the negativity stems from concerns over conflict in Ukraine and reported euro zone growth at 0.3 percent in the fourth quarter. Although inflation isn't a problem for now, almost no analyst is forecasting robust acceleration for the year in the region, which is expected to expand about 1 percent in 2014.

Beneath this lackluster scenario, though, lie several layers of companies that are part of Europe's turnaround story. If you focus on smaller-cap companies and those paying dividends, the picture is a mite brighter.

Here are two options you might consider:

The FirstTrust Europe AlphaDEX exchange-traded fund , invests in an equal-weighted portfolio of European stocks, some of which aren't the name-brand companies found in most capitalization-weighted portfolios.

The AlphaDEX holdings include roughly 1-percent positions in companies like Bank of Piraeus S.A. , Faurecia S.A. and Valeo S.A. . Year-to-date, the fund has gained 7 percent, compared to 1 percent for the MSCI EAFE Index, a benchmark of international stocks, through February 28.

By avoiding concentration in many of the mega-caps dominating most European portfolios, the AlphaDEX has sampled several smaller companies poised for growth, especially those in weaker but recovering euro zone economies such as Greece, Ireland and Spain. The fund charges 0.80 percent annually for management expenses, which is nearly twice the average for similar funds. It's a pricey fund, but worth the expense if the returns continue.

For a more focused approach on small-company stocks, consider the WisdomTree Europe SmallCap Dividend Fund . This combines a preference for dividend-paying stocks with a selection of companies in the bottom 25 percent of market capitalization of the WisdomTree Europe Dividend Index. The fund managed to capture the dramatic rebound in stocks from Ireland, Portugal and Italy.

The WisdomTree fund holds stocks such as Logitech International SA , Drillisch AG and Unipol Gruppo Finanziario SpA . The fund has returned 8 percent in the year to date through Feb 28. It charges 0.58 percent for annual expenses.

CAST A WIDER NET

Keep in mind that a small-company play in Europe is no substitute for a wider approach that would encompass a broad-based recovery throughout Europe. But widespread prosperity is slow in coming to the continent and may need more of a jumpstart.

According to the recently issued "Macro Investment Strategy" from BMO Private Bank in Chicago, developed international markets such as the euro zone need some sort of catalyst to move higher.

BMO expects that to come in the form of euro zone policymakers stimulating their economies this year, "resulting in equity gains on the back of Euro weakness."

So far this year, the outlook is bright: All the leading euro zone nations broke out of a recession last year.

Last month, the Markit Flash Eurozone Composite Purchasing Manager's Index, a gauge of economic activity, was at its highest point since May 2011. That's a hopeful sign that manufacturing and job creation will pick up in a low-inflation, low-interest rate environment. Euro zone manufacturing rose last month in all four of Europe's biggest economies for the first time in three years.

Want to cast a wider net among the big-name euro zone stocks? The iShares Trust S&P Euro holds companies like Nestle SA , Novartis AG and Roche Holding AG . The fund is up 2 percent this year through Feb 28. It charges 0.60 percent in annual management charges.

Another worthy big-basket European fund is the Vanguard FTSE Europe ETF , which is a much-less expensive way of holding the biggest European companies. The Vanguard fund holds many of the same companies in the iShares portfolio, but tracks a different index and only charges 0.12 percent annually in management expenses. It's also up 2 percent year to date.

Yet modest gains may not materialize in the euro zone if other global players such as the U.S. and China slow down. That fear was a major thorn in the side of mega-cap U.S. stock returns earlier this year as measured by the S&P 500 index, which is up about 1 percent this year through February 28 after a 32-percent return last year.

Thinking long-term, the broader the strategy, the more you will have exposure to the largest global companies based in Europe and the continuing recovery, which is still a work in progress.

(Editing by Beth Pinsker)

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