By Laurence Fletcher and Jon Sindreu

Elections in France, Germany and the Netherlands offer a calendar of concerns for European investors in 2017, which is creating some tempting trades for hedge funds and other investors.

Since the U.K. voted to exit the European Union, investors have fretted about the possibility of spreading anti-EU sentiment, calling the future of the bloc into question. But some hedge-fund managers have bought the euro or European stocks to benefit if these worries proved misplaced.

"There's too much fear in European assets," said Vincent Chailley, chief investment officer of London-based H2O Asset Management, which manages $12 billion in assets.

Mr. Chailley said he was positioned to profit from rising European stocks in his absolute return and Barry investment funds, which aim to profit from market dislocations and a lack of liquidity. He has put his trades on via both options and the spot market.

On top of long-running concerns about lackluster growth and deflation, investor worries for 2017 have focused on the debt-mountain and political instability in Italy, where stocks have fallen almost 20% since summer 2015.

Other focuses include the possibility of National Front leader, Marine Le Pen, winning the French presidency, or Greece's debt crisis flaring up again.

Mr. Chailley said the options market has been pricing in a 30%-to-50% chance that Ms. Le Pen, who has pledged to take France out of the euro, will win 2017's presidential election.

"The real probability is a lot lower than that," he said.

Thesingle currency has fallen 22% against the dollar over the past three years and is down 3% since November's U.S. presidential election, with the dollar boosted by expectations that President Donald Trump's policies will support U.S. growth.

Investors' caution in recent years has left European stocks much cheaper than U.S. stocks. Despite a rally in recent months, the Stoxx Europe 600 is trading at 15 times the expected earnings of its component companies over the next year, whereas the S&P 500 index is trading at 17 times earnings.

Hedge funds have taken note of those metrics. The percentage of Stoxx 600 shares out on loan--a good indication that funds are betting on falling prices--fell 13% between early December and last week, according to data group Markit.

"Europe is a great opportunity now," Christopher Rossbach, managing partner of London-based investment company, J. Stern & Co, said.

Mr. Rossbach expects a reboundin corporate earnings. He has been buying stocks such as German industrial adhesives company, Henkel, and Swiss cement company, Sika.

Other investors have focused on the bond market, where rising yields often point to an improving economic outlook. Yields move inversely to bond prices.

"There is a consensus that Europe is uninvestable, but the macro data is good; inflation is rising," said Alberto Gallo, partner at Algebris Investments, which manages around $6 billion in assets.

Mr. Gallo is shorting 10-year bonds in France and Italy, while going long on U.S. 10-year Treasurys.

Some asset managers based in mainland Europe have long felt that European assets have been unjustly battered.

"The Anglo-Saxon world in general is very, very skeptical of the possibility that the euro area remains in place in the next few years," said Giordano Beani, chief investor in Italy for Amundi, Europe's largest asset manager with EUR1.3 trillion ($1.4 trillion) under supervision.

Mr. Beani expects Eurozone markets to gather strength in the second half of 2017, saying euroskeptics' grab for power is likely to fall short.

Paul O'Connor, head of multi-asset investments at Henderson Global Investors, thinks the recent market moves, chiefly in the U.S. dollar, are overdone.

"We have never been so convinced that the reflation will be as U.S.-centric a story as markets had initially priced," he said. "The European and the Japanese equity markets are natural ways to play this theme."

Write to Laurence Fletcher at laurence.fletcher@wsj.com and Jon Sindreu at jon.sindreu@wsj.com

(END) Dow Jones Newswires

January 26, 2017 07:54 ET (12:54 GMT)

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