By Ankika Biswas and Ankita Yadav

(Reuters) -European equity markets are drawing fresh interest from global investors, as resilient returns and cheaper valuations offer a compelling case for diversification beyond Wall Street.

Amundi, Europe's largest asset manager, and M&G Investments are among firms reallocating portfolios toward the region. Amundi has rebalanced its long-equity positions into Europe, Japan and emerging markets since late-2024, while M&G - which oversees about $395 billion - is "overweight" European stocks and "underweight" U.S. peers.

European stocks are "a way for us to diversify (while still) staying risk-on," John O'Toole, global head of multi-asset solutions at Amundi, which manages $2.6 trillion, told the Reuters Global Markets Forum.

Fiscal policy initiatives, such as Germany's 500-billion-euro infrastructure fund, exempt from its strict debt brake, and the euro zone's pledge to lift defence spending to 3.5% of GDP under NATO's new targets, are boosting sentiment.

O'Toole described these fiscal initiatives as "game-changing", adding that central banks also continued to support the real economy.

Europe's benchmark STOXX 600 has climbed 9.2% this year, bolstered by a 62% surge in aerospace and defence stocks. That compares with the S&P 500's 13.3% gain, largely powered by AI-related momentum. Even so, Europe's valuations remain comparatively cheaper: the STOXX 600 trades at 15.6 times forward earnings, versus 25.3 for the S&P 500, LSEG data showed.

The valuation gap between U.S. and European markets has been long-standing and driven by differences in sectors, funding costs, accounting rules, incentives and regulations. The historical gap, along with other factors, is presenting an attractive diversification opportunity.

Europe's fiscal outlook is getting better, said Stephen Parker, co-head of global investment strategy at JPMorgan Private Bank. "(It's) a market that is trading at a significant discount to the U.S., and offers a meaningfully higher dividend than the U.S."

Fabiana Fedeli, chief investment officer of equities, multi-asset and sustainability at M&G Investments, said the valuation gap is leaving "mispriced opportunities" in sectors overlooked by global investors. She pointed to energy infrastructure and diversified financials alongside technology and healthcare.

"We do invest in defence, but many companies in Europe have been performing strongly on other trends, less noticed by the wider investor community," she said.

However, risks remain for European markets, including U.S. tariffs on goods such as automobiles and steel, currency fluctuations affecting price competitiveness, economic slowdowns, investment challenges and uncertainty surrounding fiscal policies.

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