U.S. investors tend to regard the European Union as a region of low growth, an area of the world that has little to offer to non-EU investors.

For much of the EU, this is true (I’ve never found much of anything that’s investment-worthy in Italy, for example).

Overall, however, this anti-EU sentiment is pretty unfair.

In fact, it’s now becoming increasingly clear that even U.S. investors would be mad not to have some of their money in Germany.

A Mixed History

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And to really maximize the profit potential of your portfolio, you need to have money in Germany – at least 5% to 10% of your overall portfolio.

Although Germany seems to occupy a kind of “show-me” status among investors today, it was once a favored investment destination for the investors who understood even then how important it was to diversify into international markets. That was especially true prior to the July 1990 reunification that saw the former East and West Germany merge into a single entity.

In the 1950s and 1960s, the former West Germany enjoyed truly stellar growth under wise Chancellor Konrad Adenauer as it recovered from World War II, and from the 100 years of rule by the economically illiterate governments that had guided it in the previous century.

If you’re a free-marketeer, you probably prefer Bismarck to Kaiser Wilhelm II, “Kaiser Bill” to the socialists of the 1920s Weimar Republic, and the Weimar guys to the Third Reich (though your overall vote would go to “none of the above”).

After the 1960s, Germany’s growth rate slowed. But after 1971, the country’s currency took off against the U.S. dollar. So if you were an investor in Germany, you still made out from both profit growth and from currency appreciation.

Then came reunification. The Berlin Wall fell in 1989 and the two Germanys were reunited the following July.

Germany’s Economic Resurgence

Mistakes were made in setting up the union and for the next 15 years the combined German government poured subsidies into the former East Germany at a rate of about $100 billion annually – equal to about 3% of the entire country’s gross domestic product (GDP).

The upshot: German growth slowed to a crawl, and impatient foreign investors invented the myth that Germany lacked entrepreneurship and was too socialist to do well in a free-market world.

Since 2005, however, Germany’s growth has re-accelerated. This should not have surprised anybody; the costs of re-unifying the country were always likely to be finite and the dynamic West Germany was around four-fifths of the total in terms of population and even more in terms of GDP.

German labor costs per unit of output were the highest in the EU at the formation of the Eurozone. But they fell by more than 20% over the next 10 years, making Germany highly competitive internationally.

As the costs of East German unification began to decline, the government undertook tax reforms, reducing corporate taxes and high-rate individual taxes to internationally competitive levels. Then, unlike almost every other country when the 2008 crisis hit, the German government avoided the “stimulus” folly, with the finance minister – at that stage a Social Democrat – describing it as “crass Keynesianism.”

As a result, the German economy has recovered much more strongly than most. Unemployment has remained limited, at 7.5% currently compared with a peak of greater than 10% in the United States. And Germany’s GDP has begun advancing at a fairly healthy clip: The growth rate of 3.6% in 2010 far exceeds the expected level for the United States, Japan, or the rest of the EU. This is the highest growth since pan-German data began in 1991, and was accompanied by a 9.4% rise in corporate spending on equipment, again well ahead of Germany’s competitors.

In other words, Germany appears to have reverted to its healthy-growth proclivities of the 1980s and before. And its relative strength is likely to continue.

Unlike the United States, Germany runs a healthy trade surplus, indicating that its industries are highly competitive in world markets. German companies outsource – but generally to Eastern Europe, rather than Asia. That represents sound strategic management, since the German skills of extremely high precision manufacturing, taut workforce discipline and tight process control cannot easily be applied in an unfamiliar culture far from home.

Then there’s valuation. Germany’s stock market is currently cheaper than its U.S. counterpart (15 times earnings, compared to 17 times for U.S. stocks, according to The Financial Times) – even though the German economy is growing at a faster pace.

The difficulty is how to invest.

How to Reap the Predicted Payoff

Relatively few German companies have full American Depository Receipt (ADR) listings in the United States. That’s partly because the U.S. Sarbanes-Oxley Act requirements are expensive, making it prohibitive for German companies to list here. Plus, German companies have an excellent investor base, both domestically and through London and the rest of the EU.

I have found one tech company in my Merchant Banker’s Alert advisory service that I think is pretty special. But German companies with ADRs are generally very large and operate in traditional sectors, without much growth. Germany’s unique capabilities come to the fore best in medium-sized companies, generally with family management, which may be listed on their domestic market, but not in New York.

That leaves funds. And fortunately, there is one very good choice here.

There is an exchange-traded “country” fund (ETF) for Germany, the MSCI Germany Fund (NYSE: EWG), but that also has heavy exposure to the slow-growing behemoths.

[ad#ChinaBlankCheck]Thus, my favorite right now is a closed-end fund, the New Germany Fund Inc. (NYSE: GF). This $300 million fund is run by Deutsche Bank AG (NYSE: DB) and has the additional advantage of trading currently at a 10% discount to net asset value (NAV) – so you get $100 of asset exposure for a $90 investment.

The fund specializes primarily in medium-sized and smaller German companies, which is just where we want to be: Those are the companies that have the biggest exposure to the fast-growing domestic economy; they’re also the most innovative.

Actions to Take: If you haven’t already, it’s time to invest in Germany, a faster-growing and better-managed economy than its U.S. rival, and one that can provide a very nice payoff.

Because of restrictive U.S. regulations, there aren’t many ways for U.S. investors to buy into German firms via U.S. exchanges. But there is a closed-end fund that represents an excellent choice. This investment, the New Germany Fund Inc. (NYSE: GF), is a $300 million fund run by Deutsche Bank AG (NYSE: DB). It is currently trading at a 10% discount to NAV.

The fund specializes in the very companies we want to invest in – the medium-sized and smaller German companies that are the most innovative, and that have the biggest exposure to the fast-growing domestic economy.

— Martin Hutchinson

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Source:  Money Morning