Henderson EuroTrust

The new manager is now outperforming, meaning HNE’s current discount is an interesting proposition…

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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Henderson EuroTrust. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Henderson EuroTrust

Summary

Henderson EuroTrust (HNE) aims to deliver superior total returns from a portfolio of high-quality European (ex-UK) companies. After Tim Stevenson announced his retirement in 2018, Jamie Ross took over control and was named lead manager of the trust. He had been previously appointed deputy fund manager of HNE in March 2017 and then co-manager at the start of October 2018.

Jamie looks for high-quality, reliable companies, with the end goal of delivering consistent returns to investors. This involves looking for companies with strong market positions, sturdy balance sheets, consistent growth and quality management.

Jamie took over the portfolio in an unarguably challenging environment, with political and macroeconomic uncertainty swirling around Europe. However, so far in 2019 (to 31 October) the trust has outperformed, generating 20.16% NAV total returns relative to FTSE World ex-UK total returns of 17.5%. HNE has also outperformed both the AIC peer group average (by 2.3%) and the IA peer group average (by 4.3%) over the same period.

Due to this, Jamie looks as though he is on course to continue HNE’s impressive track record, which has now outperformed the benchmark in nine out of the last ten years. This impressive feat isn’t always recognised in the discount, which has been quite volatile over the past few years, ranging from a premium to a double-digit discount. The current discount sits at 9.2%, which is towards the bottom end of HNE’s historical range.

Kepler View

The consistency of outperformance in difficult markets – as well as those which have been more positive – is one of the hallmarks that differentiates Henderson EuroTrust from the crowd.

Jamie, who came to the helm at a particularly tricky time, has so far proved himself a worthy successor to Tim Stevenson. Although it is likely that Germany has entered a recession, whereas Italy has struggled to avoid recession and the cloud of Brexit continues to see investors shy away from the European region, Jamie has taken the negative investment environment in his stride, and performance this year has so far been strong .

This strong relative performance is yet to be reflected in the trust’s discount, which has widened in comparison to its one-year average. In fact, the trust’s discount of 9.2% sits well below the peer group average, despite HNE being one of the standout performers over the past one, three and five years. As such, there is a decent chance that HNE could re-rate, and the discount narrow. As such, whilst also getting exposure to some of the unique companies that Europe has to offer, the current discount is a potentially attractive entry point for investors.

bull bear
The new manager has started strongly, outperforming peers and the benchmark over 2019 so far
Jamie is a less experienced new manager without a long-term track record in European equities
A more concentrated portfolio offers the potential for strong alpha generation
Uncertainty continues to cloud investor sentiment towards Europe
Discount is at a historically wide level
Sterling strength could provide a headwind to NAV and dividend

Portfolio

Jamie Ross took the helm of Henderson EuroTrust (HNE) in 2019, with Tim Stevenson retiring after a 25-year tenure as manager. Jamie had previously been working as co-manager of the trust since October 2018, and before that as deputy fund manager since March 2017.

On the whole, the investment style and process has remained consistent, and the portfolio retains its clear bias towards high-quality companies capable of very significant growth. Although the focus is on Europe, Jamie looks for companies that operate in the global sphere while being listed and headquartered in Europe.

Jamie and his team look to invest in companies where, in his view, there is limited risk of a material impairment of capital; any holding must have potential returns that are multiple that of the potential losses. A key focus for Jamie when looking at prospective investments is their historical (and potential) ROIC (return on invested capital). This is a measure of profitability, with the focus being on finding companies that can deliver returns sustainably above their cost of capital. In determining this, Jamie looks at a company’s market position, balance sheet, consistency of growth and quality of management. The ultimate aim is to own companies for the long term that can consistently increase returns to shareholders, perhaps through industry tailwinds or through the specifics of the company/management.

One change Jamie has made since taking over sole management of HNE is to increase the concentration of the portfolio. The view is that having fewer high-conviction stocks will help him (as manager) deliver greater returns for shareholders. Alongside this, having a more concentrated portfolio will help the trust to further differentiate itself from peers and passive ETFs. When we met with Jamie recently, this was clearly a point that he feels particularly strongly about, and he emphasised that he sees it as his role to deliver alpha through having high conviction in his decisions. Currently the portfolio is made up of just 45 holdings – down from the 55–60 range typically held by his predecessor. The size of each holding is expected to range between 0.8% to 1% (for the smallest holdings) up to a maximum of 6%. Typically, the largest positions in the portfolio will be the less risky, steadier ideas, whereas the smaller holdings will offer greater return opportunities but with higher volatility.

Overall, the portfolio will still remain diversified, and as such the intention is that shareholders should not expect a significant increase in volatility associated with the increased portfolio concentration. Janus Henderson calculates that annualised volatility over the five years leading up to Tim Stevenson’s retirement was 10.7% per annum, whilst over the same time period the benchmark had volatility of 11.1%. Since Jamie took over sole charge of the portfolio in February 2019, the NAV has demonstrated volatility of 10.5% per annum, compared to the benchmark of 10.7% per annum. Clearly it is early days yet, but it would appear that the more concentrated portfolio has not so far been exhibiting significantly higher volatility than the market.

The companies in the portfolio share quality and growth characteristics, but Jamie splits them into three broad classifications to help him manage the portfolio: compounders, improvers and special opportunities. Compounders are high-quality companies that should generate strong and sustainable returns. Jamie looks to hold these companies through the up and down cycles of the market. The median holding within this bucket trades on a price-to-book ratio of 6.3x and offers a return on equity of 23.1%. It is anticipated that over the long term these companies will typically make up the majority of the portfolio, and as of July 2019 they represent well over half of it (61.4%). An example of this type of company is Novo Nordisk, a Danish-listed pharmaceutical company which specialises in diabetes and obesity. Historically the company’s focus has been on insulin, but over recent years its focus has been shifting towards an orally taken diabetes product (in the GLP-1 class of drugs) that has been proven to show strong effectiveness in controlling blood sugar and also provides benefits in the weight loss sector. Importantly, the product provides an alternative to injection systems for Type 2 diabetes. Novo Nordisk’s ROIC is very high, driven by high gross margins from its intellectual property, which means continued R&D expenditure looks sustainable. In Jamie’s view the market continues to misprice the company because of the focus being given to the declining price of insulin around the world, even though this has less and less relevance to the company thanks to the new GLP-1 drugs.

The second classification – improvers – includes companies that are not priced correctly for their improving returns profile. The companies within this bucket currently trade on an average price-to-book ratio of 1.5x, and deliver an ROE of 11.2%. Currently, improvers make up c.23.1% of the portfolio. An example of this category is DSM, a Dutch chemicals company that has a market cap of around €20bn and is shifting its exposure away from chemicals towards ingredients, which is a much more attractive and less commoditised business. Jamie acknowledges the progress that the company has made already, which has seen its return on invested capital increase materially, but he nonetheless sees scope for significant incremental improvements in the coming years.

The final classification bucket includes companies that Jamie considers ‘special opportunities’. These are investments that are based around a specific event or catalyst, and at 16.4% of the portfolio they represent the smallest allocation. The companies within this bucket trade on an average price-to-book ratio of 2.1x, and deliver an ROE of 6.8%. An example of a company in this category is Vivendi, a French media company offering exposure to music, TV, gaming and media agencies. The main focus for Jamie is Vivendi’s music business, of which Universal Music Group (UMG) makes up over 60% of the company’s value. UMG has a leading market position, which Jamie believes will be a key beneficiary of the global rise of subscription music streaming by the likes of Spotify and Apple Music. ROIC has been low for a number of years thanks to music piracy via the internet; however, Jamie sees a healthy future for the company due to margins expanding as a result of the growth of music streaming. The catalyst (or ‘special situation’) is an upcoming partial sale of UMG to a strategic partner – initially rumoured to be Tencent, but according to Vivendi there are a number of other interested parties. Jamie believes a transaction will support the team’s view that UMG’s value is underappreciated within Vivendi’s conglomerate structure.

On a sectoral basis, industrials are the largest overweight within the portfolio (at 21%), followed by communication services (at 13.75%) and materials (at 7.77%). At the other end of the spectrum, Jamie is currently shying away from the consumer discretionary sector (at 4.3%), consumer staples sector (at 4.7%) and utilities sector (at 1.8%), to which HNE is underweight. This being said, Jamie is a purely bottom-up stock picker and does not make decisions based on a particular sector. The same can be said for geographical exposure, and Jamie believes that a company’s domicile is irrelevant.

Gearing

In normal circumstances, the board anticipates HNE will be fully invested. However, the manager has discretion as to what level of gearing the trust employs at any one time. Jamie has said that he expects a ‘neutral’ level of gearing to be 3 to 6% at any one time. He has an overall range of gearing set between a maximum of 20% of NAV in cash (ie ungeared) or (as a maximum) gearing of up to 30% of total assets. Currently the team utilise a short-term debt facility of £25m, and we understand that the facility has been used quite flexibly in the past.

Short-term movements in gearing are either dependent on opportunities presented by stock ideas or by overall levels of valuations in the portfolio. Jamie manages a watch-list of investments, alongside the current portfolio. Running a concentrated portfolio requires focus and discipline, and usually he applies a ‘one in, one out’ rule when investing in new ideas. However, if he can’t find a stock he wants to sell, then he will use gearing to add to the new holding. Alternatively, if the overall level of valuations in the portfolio is looking attractive, then he might decide to add exposure across the portfolio by drawing down on the gearing facility. This latter approach is well illustrated by gearing levels since the summer of 2018. In August 2018, Jamie (and also Tim at that stage) observed that the market had been performing strongly, but the two of them saw relatively few interesting new ideas at valuations they saw as attractive. As a result, HNE wasn’t employing any gearing at that time, but after the market falls in Q4 of 2018, Jamie re-introduced gearing in early 2019. Given the subsequent returns from equity markets since then, this will clearly have benefited shareholders. Gearing currently sits at approximately 4% (as at 31 October 2019), reflecting Jamie’s more balanced outlook.

Returns

Since HNE’s inception, the returns it has delivered have been nothing short of exceptional and illustrate the power of active management as well as the long-term compounding of returns. Since its launch in 1992, the trust has delivered an NAV total return of close to 2,633% up to mid-November 2019, more than double the benchmark FTSE World Europe ex-UK returns of 1,107% over this period. As the below graph (which illustrates calendar-year returns since 2011) shows, the trust has outperformed the benchmark consistently in discrete terms, with the only year HNE didn’t outperform being 2014. In the calendar year to 21 November 2019 things are so far shaping up nicely, with the trust outperforming the benchmark, as well as the average of its open- and closed-ended peers. In our minds, the consistency of outperformance in difficult markets as well as more positive ones is one of the hallmarks that differentiates Henderson EuroTrust from the crowd.

returns

Source: Morningstar, 2019 = to 21st November

The trust’s NAV performance has been equally strong over the five-year period to 21 November 2019, with the trust delivering NAV total returns of 76.2% against the benchmark’s 54.5%. Returns are equally impressive relative to the average for open- and closed-ended peers, with them having delivered 65.3% and 53.2% respectively. Over this period alpha generation has been strong at 2.83% per annum, which was achieved with relatively low levels of volatility (10.8%) compared with the benchmark’s volatility of 11.1% (Source: Janus Henderson).

five-year nav performance

Source: Morningstar

As can be seen below, since Jamie was appointed deputy manager in March 2017 the performance has been largely ahead of the benchmark, despite the challenging environment that he had come into. Perhaps most encouragingly, most of the outperformance has been generated in the last couple of months. Although the trust was unable to generate positive returns over 2018, HNE still outperformed the benchmark. From the start of 2019 to 31 October, the trust has generated 20.16% NAV total returns, relative to FTSE World Europe ex-UK returns of 17.5%. The trust has also outperformed the AIC peer group by 2.3%, and the IA peer group by 4.3%, over this period (Source: Morningstar).

ytd performance

Source: Morningstar

Dividend

Since 1995, the trust has focused more on growth and total returns rather than the dividend per se. That said, the board and manager aim to provide a growing level of dividend to shareholders over time. As such, and as the graph below shows, the dividend growth over the years has been impressive, running at a compound annual growth rate of 12.4% per annum over the past five years, ahead of the sector average of 11.2%. The current dividend yield is 2.7%, significantly ahead of the weighted average of the sector of 1.7%.

In October 2019 HNE announced that the full-year dividend would be 31p, up from 30.5p in 2018. The board had warned shareholders via last year’s report and accounts that the pace of dividend growth was likely to moderate, particularly given the influence that the GBP/EUR exchange rate has on dividends being translated back into sterling. After contributing £1.8m to the revenue reserve in the previous three years, the board decided to use some of the revenue reserve to increase the dividend in the current year. Earnings per share during the year to 31 July 2019 were 29p, meaning a 2p-per-share contribution to dividends from the revenue reserve. We calculate that revenue reserves now stand at 0.53x the current annual dividend. This move by the board reflects its ambition for a progressive dividend, but also reflects past patterns that have seen the board dip into revenue reserves to maintain dividend progression.

historic dividend

Source: Janus Henderson, 2018 dividend includes a special dividend of 2p.

Management

Tim Stevenson, long-term lead manager of HNE, officially stepped down from managing the portfolio on 28 February 2019. Jamie Ross, who was appointed as deputy manager in 2017 and had been working with Tim since 2016, is now the lead manager.

Jamie joined Janus Henderson in 2007, initially working as a trainee fund manager in European equities before becoming a co-manager on the Henderson UK Alpha Fund (OEIC) in 2013. After working for the UK fund for three years, Jamie was offered the opportunity to move back to the European equity markets team, a chance that he welcomed with open arms. Jamie and Tim worked together on a range of European funds until Tim’s retirement in early 2019.

The European team have a total of 15 members (three of whom are dedicated to small caps) who run several different strategies but share thoughts and ideas.

Discount

HNE’s discount has fluctuated greatly over the past five years. As recently as 2015/2016, the trust traded on a premium. However, the result of the Brexit referendum sent many investment trusts to a discount, with HNE dipping to a low point of around 16%. Since Tim Stevenson announced his retirement in 2018, the premium rating that had once again been reached has given way to the double-digit discount which the trust currently trades close to.

discount

Source: Morningstar

As of the start of November 2019, the trust is trading on a discount of 9.2%, slightly narrower than the one-year average of 9.5% and the sector average of 8%. The board monitors the discount and premium actively and will “take action to issue or buy back shares where it believes it is in the best interests of shareholders to do so”. With this said, over 2019 no shares have been bought back and the last time the facility was used was back in July 2016, on a discount of c.12%.

Charges

As with many investment trusts, the board has been seeking to lower HNE’s ongoing charges over the past few years. As from January 2019, the historical performance fee has been removed and the management fee has been tweaked so that shareholders can start to enjoy a reduced fee once HNE’s net assets rise above £300m (currently the trust has net assets of £273m). HNE’s OCF is currently 0.81%, compared to the weighted average for the peer group of 0.89% (Source: JPMorgan Cazenove). The KID RIY cost is 0.96%, which compares to the peer group weighted average of 1.35% (Source: JPMorgan Cazenove).

ESG

Jamie Ross believes that as an investor he is not forced to make a choice between making a profit and having an ESG conscience. Jamie’s investment process focuses on understanding the quality of a business, as well as the long-term approach of the management. Clearly, in looking for long-term investments, Jamie has to consider how the management team of a company are interacting with stakeholders and society. Jamie cares passionately about the damage we are doing to the environment and the inequalities within our societies, which means it is unlikely, in taking a long-term view, that he would invest in companies which would run counter to this philosophy. As such, he believes there is a significant overlap between his approach and a specific ‘ESG-driven’ approach to investing.

Within the process, governance is a particularly important part of ESG for Jamie and the rest of the team; as we note in the Portfolio section, the team meet with company management teams regularly. For environmental and social considerations, the team have an in-house governance and responsible investment (GRI) team for support to help them understand best practice, as well as to help them consider MSCI ESG risk reports.

When we applied the Morningstar Sustainability Rating system across the 474-strong Morningstar AIC investment trust universe earlier this year, HNE was ranked the number one trust in the entire universe. Bald statistics only tell part of the story, but whilst it is clear that this is not a purely ESG-driven mandate, HNE is likely to appeal to those who want to introduce some elements of ESG into their portfolio.

Fund History

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