European equities have been largely unloved by investors for some time, having lagged their global peers over the past decade: the MSCI Europe ex UK Index has grown by circa 6% pa whilst the MSCI World Index is up circa 11% pa. European smaller companies have fared markedly better than their large cap counterparts however, outperforming the world in 2017 and growing at an annualised rate of over 10% during the last 10 years, as measured by the MSCI Europe ex UK Small Cap Index.1
Indeed, over the long term, European Smaller Companies has been one of the strongest performing sectors across the globe, as can be seen from the chart below2:
Whilst the closing months of 2019 were marked by increasing volatility driven by a slowdown in global growth, Sino-American trade wars and Brexit. All this paled into insignificance in the first quarter of 2020 when cases of COVID-19 infections were confirmed outside of China, shutting down the global economy as the virus swept from China, through Europe and on to the US.
In early March 2020, global stocks saw a downturn of at least 25%, and 30% in most G20 nations, as the pandemic inflicted rising human costs worldwide and the necessary monetary and fiscal protection measures severely impacted economic activity. Global and Euro-area growth are projected at -4.4% and -8.3% respectively in 20203, signalling the worst recession since the Great Depression. The initially savage drops in stock markets were promptly followed by a dramatic bounce from mid-March onwards, Europe included, and by the end of October 2020, a sterling investor had seen a 12-month gain on an investment in European smaller companies of circa 10%, aided by a weak pound.4
Euro small cap – the drivers of positivity
The region's smaller companies continue to be one of the more attractive investment sectors within world markets, for a host of reasons:
- it represents a unique blend of industries and companies which are less prominent in other regions
- European smaller companies have traded at a discount to their peers elsewhere over recent years, and so companies which would potentially command premium ratings in, say, the US are considerably more attractively priced in Europe
- it is an imperfect market which is ideally suited to active management, especially given the relative paucity of research available on its constituent companies: there are circa 2,500 quoted European stocks with a market capitalisation of between £100m and £5bn, compared to circa 400 with a market cap of over £5bn
- it offers exposure to high growth niches such as fintech, computer gaming, e-commerce and green energy (the EU is leading the world with its green agenda)
- the policy environment is as constructive for equities as it has been for some time – the considerable support injected into European economies by governments and central bankers – furlough schemes, guaranteed loans, interest rate suppression and the like – have had a positive overall effect and appear to have staved off the worst (although, for companies without a viable long-term business model, this support merely delays the inevitable)
- historically, European smaller company outperformance has been highly correlated to positive Purchasing Managers' Index (PMI) data – given this correlation, there is an expectation that the European small cap sector, and indeed value, will outperform as the economy strengthens and PMI data improves further
- Europe as a region is highly geared to global trade and so should be amongst the first regions to benefit from a post-COVID recovery
- at circa 1.5x, the price to book ratio (a key indicator of value) of European small cap stocks is currently some 15% below its historic average of circa 1.8x
- 2021 forecast earnings per share growth for European small cap stocks is amongst the highest of any region (see table below).5
|2021 forecast EPS growth (%)|
|UK large cap||33.8|
|UK small cap||35.3|
|US large cap||28.1|
|US small cap||40.1|
|Continental Europe large cap||37.1|
|Continental Europe small cap||46.8|
TR European Growth in 2020
Despite the unprecedented market turbulence, TR European Growth Trust (TRG) – managed by Ollie Beckett since 2011 – has performed impressively, achieving total return outperformance of 9% in its net asset value (NAV) relative to the benchmark over the last 12 months.6 Ollie attributes this achievement to a number of factors:
- an undiluted focus on the fundamental worth of a business, at a time when favouring short-term momentum would have proved very costly
- the diversity in portfolio holdings, with a mix of early-stage growth businesses, sensibly priced structural growth stocks, mis-priced value names and self-help turnaround stories: the trust currently holds circa 130 stocks
- good stock selection, primarily managing to buy online business models that have benefitted from a COVID-19 tailwind at a reasonable price
- a willingness to go down the market cap scale – early entry into these growth stocks has enabled acquisitions at low valuations
- it is not a value portfolio, valuation having been out of vogue as a stock market discipline for the last decade; despite that, the trust remains acutely valuation aware – maintaining valuation discipline throughout the market dislocation, it has taken the opportunity to buy some great businesses at good prices and some good businesses at great prices.
At a geographical level, the trust remains overweight in Germany (21.6%) and the Netherlands (8.0%), and has built a reasonably large overweight position in France (13.6%). It remains underweight in Spain and Austria, where it has proved difficult to find attractively valued opportunities for a few years. At a sector level, the trust remains overweight in technology, consumer discretionary and industrials.
The key driver of outperformance, however, has been the trust's unalloyed commitment to bottom-up stock-picking: whilst risky concentrations are always avoided, index weightings play little to no part in asset allocation and Ollie is comfortable running the portfolio with substantial divergence from the benchmark. TRG has consistently generated its own investment ideas rather than relying on external analysts, which is fortunate given the declining availability and quality of external analysis exacerbated by MiFID II. To that end, the TRG portfolio management team – Ollie, Rory Stokes and Julia Scheufler – spends hundreds of hours meeting and analysing medium and small-sized companies across western Europe – circa 600 meetings in the course of a typical year. It’s their belief that only through this level of immersive interaction and investigative rigour can the potential for significant outperformance be realised.
|Annual performance (cumulative income) (%)|
|Discrete year performance % change (updated quarterly)||Share Price||NAV|
|30/09/2019 to 30/09/2020||13.4||16.8|
|28/09/2018 to 30/09/2019||-11.4||-8.4|
|29/09/2017 to 28/09/2018||-10.9||-5.5|
|30/09/2016 to 29/09/2017||56.1||37.4|
|30/09/2015 to 30/09/2016||33.6||40.7|
All performance, cumulative growth and annual growth data is sourced from Morningstar, as at 31st October 2020. Past performance is not a guide to future performance.
Depending on dividends
Despite not targeting income, one of the attractive aspects of the trust relative to its peers is its dividend payment solidity: over the last five years, average annual dividend growth of 25.7% is the highest in its sector.7 A final dividend of 14.20p to shareholders was agreed at the 2020 annual general meeting and, together with the interim dividend of 7.80p, brings the total dividend for the year to 22.00p, in line with last year – no small feat given Q2's widespread corporate dividend-cutting and suspensions.
Dividend history (pence/share)8
Since the end of October, the trust's outperformance has accelerated post the positive news regarding the Pfizer vaccine, coupled with renewed investor attention on value. Looking beyond COVID-19, some voices are contending that we will see new lows in the market; Ollie doesn’t agree, being of the view that, whilst the market may again show some volatility later in the year as we emerge from the virus lockdown, confidence in an economic recovery is tested, and – as we've said – sentiment will undoubtedly be bolstered by the rollout of the Pfizer and AstraZeneca vaccines.
European smaller companies continue to be an attractive area. As already stated, it’s an imperfect market and the TRG team is confident that the hard work it puts into understanding the companies in its universe will enable it to continue to take advantage of further opportunities and mispricing, thereby identifying ongoing sound prospects for the deployment of shareholder capital.
1EUR, 10 years to 30.11.20
2Source: Janus Henderson, DataStream, in GBP, as at 31.10.20. Indices used: Euromoney Smaller European Companies ex UK, FTSE 100, FTSE 250, S&P 500, MSCI Emerging Markets, Datastream UK 10-Year Gilt, MSCI Europe ex UK
3Source: International Monetary Fund, World Economic Outlook, October 2020
4Source: MSCI Europe ex UK Small Cap Index, year to 31.10.20
5Source: TR European Growth Trust PLC, Annual Report 2020
6Source: Morningstar, relative to EMIX Smaller European Companies ex UK Index, as at 31.10.20
7Source: Association of Investment Companies/Morningstar, as at 18.11.20
8Source: Morningstar, as at 31.10.20.
Volatility – The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment
Market capitalisation – The total market value of a company’s issued shares. It is calculated by multiplying the number of shares in issue by the current price of the shares. The figure is used to determine a company’s size, and is often abbreviated to ‘market cap’.
Price-to-book (P/B) ratio – A financial ratio that is calculated by dividing a company’s market value (share price) by the book value of its equity (value of the company's assets on its balance sheet). A P/B value <1 can indicate a potentially undervalued company or a declining business. The higher the P/B ratio, the higher the premium the market is willing to pay for the company above the book (balance sheet) value of its assets.
Gearing - A measure of a company’s leverage that shows how far its operations are funded by lenders versus shareholders. It is a measure of the debt level of a company. Within investment trusts it refers to how much money the trust borrows for investment purposes.
Monetary (protection) policy - The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. It includes controlling interest rates and the supply of money. Monetary stimulus refers to a central bank increasing the supply of money and lowering borrowing costs. Monetary tightening refers to central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money. See also fiscal policy.
Fiscal (protection) policy - Government policy relating to setting tax rates and spending levels. It is separate from monetary policy, which is typically set by a central bank. Fiscal austerity refers to raising taxes and/or cutting spending in an attempt to reduce government debt. Fiscal expansion (or ‘stimulus’) refers to an increase in government spending and/or a reduction in taxes.