TR European Growth

Utilising a unique process, TRG offers a value-tilted portfolio of smaller European companies…

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This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour. 

TR European Growth

Summary

TR European Growth Trust (TRG) aims to deliver capital growth by investing in smaller and medium-sized companies in Europe (excluding the UK). It tends to own smaller companies, on average, than the majority of its peers and pursues a contrarian valuation driven approach which sees it more highly exposed to ‘value’ plays than others in the sector.

With a strong record of dividend growth, the trust offers a solid yield, and is insulated from the threat of dividend cuts by a large revenue reserve. Though well diversified, the trust’s high gearing and preference for smaller, often out-of-favour, companies has meant significant volatility for investors. Ollie Beckett has been running the portfolio since 2011, utilising a bottom-up approach to stock selection. The investment process differentiates the trust from others in the sector, as it involves assessing companies based on the stage of their life cycle as opposed to by sector or geography. Depending on where each company sits in its cycle, Ollie will assess different attributes, valuation metrics and sell signals to understand if it is intrinsically undervalued.

The trust is well diversified with close to 150 stocks, and the top ten holdings make up less than 20% of NAV. There is an emphasis towards small- and micro-cap companies relative to peers, with the average market cap in the portfolio £916m, in comparison to the AIC European Smaller Companies sector average of £1.69bn. Ollie pursues a contrarian approach, looking for undervalued companies which he believes are misunderstood by the market, and has been increasing his exposure to companies with leverage throughout the pandemic.

Typically, the trust has outperformed in rising markets but done little to protect capital during falling markets. This is primarily due to the type of company Ollie invests in, as well as the high levels of gearing employed (currently 11%). Over the past five years the trust has delivered NAV total returns of 32.4%, outperforming the benchmark but underperforming the AIC European Smaller Companies sector.

Currently the trust is trading at a discount of 16.4%, the widest in the sector.

Kepler View

TR European Growth Trust looks unlike other trusts in the sector because of its unique investment process and its high exposure to ‘value’ stocks. Through looking at companies based on the stage they are at in their life cycle, Ollie has built a portfolio with a highly differentiated blend of stocks at different stages of their growth trajectories.

The high levels of gearing the trust employs have meant that the trust’s performance has often risen or fallen at a much greater rate than the benchmark or peer group. Interestingly, despite the focus on stages of growth and the small- to micro-cap focus tilt, the trust has higher-than-average levels of exposure to ‘value’ stocks. This has further increased throughout the pandemic, as Ollie looks to take advantage of companies whose leverage means they are being hit particularly hard. Although a risky strategy, the highly diversified nature of the portfolio offers a degree of reassurance.

Although capital growth is the main aim for the managers, the yield of 3.1% is also attractive. Investors should be aware though that dividends will still likely be cut in European smaller companies, though in this scenario the trust’s large reserves put it in a stronger position than most.

The current discount (16.4%) could be an attractive entry point into the trust for those who believe the worst is behind us and a recovery awaits. However, the characteristics described above – and particularly the gearing, at a trust level and in the underlying holdings – could prove troublesome should we see continued lockdowns through Europe.

bull bear
Highly differentiated portfolio relative to peers Highly geared
Attractive source of diversified income with revenue reserves that mean it is likely to withstand dividend cuts better than others Value-driven approach has been out of favour for the past decade
Wide discount Highly diversified portfolios can struggle to offer returns that are significantly different from the benchmark

Portfolio

Long-term fund manager Ollie Beckett has an investable universe of around 2,000 companies. This long list is reduced through a series of quantitative screens, which help Ollie identify those companies that he believes are intrinsically undervalued. After assessing the fundamental data, Ollie will then look to meet as many companies as he can, using this time to further understand their business models and drivers of growth, as well as the quality of their managements.

The trust has more than 30% of its portfolio in what Morningstar models define as ‘value’ companies, considerably more than the sector average of 13.4%. However, Ollie stresses that TRG is not a value trust. Instead, he just places the upmost importance on what he pays for the cash flows of a company, as this will ultimately be what drives market prices over the longer term. The portfolio has a bias towards smaller- and micro-cap companies, with the average holding’s market cap sitting at £916m, in comparison to a sector average of £1.69bn. Currently, 28.9% of the portfolio is in micro caps (as defined by Morningstar). No other trust in the sector has double-digit exposure to micro caps.

A unique aspect to the process is the assessment of companies on the basis of life-cycle, as opposed to through a sectoral or geographical lens. Depending on where the company sits in its life cycle, Ollie will be looking for different attributes, valuation metrics and sell signals. For example, with an early-cycle company Ollie will want it to have a clear business strategy, growth and a high operating leverage, notably the EV/sales ratio. However, should the company begin to show disappointing growth, narrative drift, evidence that directors are selling or weaker operating leverage, then Ollie will sell the position. In comparison, for a company in the turnaround stage, he is looking at factors such as cost-cutting, profit margins and asset disposals. The most relevant metrics for this stage are EV/IC, EV/EBIT and the FCF yield. If he should stop seeing margin progression or notice rapid sales deterioration, he will begin to reduce the position in a company.

company life cycle

Source: Janus Henderson

As well as helping to identify opportunities, this process helps Ollie to ensure the portfolio is well diversified. In particular, as regards the types of growth that can be expected. Typically the portfolio will be made up of between 120 and 150 companies, and currently it is towards the top end with 147 (as at 14/05/2020). This is comfortably the most diversified trust in terms of holdings in the sector, where the average number of holdings is 93. Of TRG’s holdings, the top ten make up just 18.5% of the portfolio, as can be seen below.

top ten holdings

Company
asset allocation (%)
Van Lanschot Kempen
2.2
DFDS
2.0
FinecoBank Banca Fineco
2.0
Medios
2.0
Nexans
1.9
Banca Farmafactoring
1.8
Karnov Group
1.8
Soitec
1.7
Gaztransport et Technigaz
1.6
TKH Group
1.6

Source: Janus Henderson

At a geographical level, the largest positions are held in Germany (18.5%), France (14.9%) and Switzerland (12.5%). At a sectoral level, the largest exposures are in industrials, consumer discretionary and information technology. That said, these allocations are purely the result of stock selection, as opposed to any particular macroeconomic view.

geographical exposure

Source: Janus Henderson

Gearing

Gearing is used actively by the team at TRG, reflecting the manager’s keenness to take full advantage of the benefits the investment-trust structure can offer. The team use gearing to maintain flexibility as investment opportunities arise, freeing them from the need to urgently raise cash by selling assets at poor prices. Borrowing comes in the form of a flexible multicurrency overdraft arrangement with HSBC, up to the amount of £100m.

As can be seen below, over the past year gearing levels have reached as high as 16.3%, and as low as 8.8%. At the time of writing (15/05/2020), the trust’s gearing is 11% of net assets.

Gearing

Source: Morningstar

Returns

Performance of the trust is measured against the EMIX Smaller European Companies Index and, since Ollie Beckett took over the trust in 2011, relative returns have been strong. Over this nine-year period the trust has delivered NAV total returns of 94.5%, in comparison to the benchmark returns of 79.5%. However, relative to the peer group the trust has struggled, particularly in recent times (as discussed below), with the AIC peer group returning 111.3%.

returns

Source: Morningstar

The trust tends to outperform during rising markets, as shown in the calendar-year graph above. Between 2016 and 2017, for example, the trust had NAV returns of 62.1%, eclipsing the benchmark (41.4%) and the AIC peer group (44.1%). However, the performance has then dramatically dragged during falling markets. In 2018, for example, the trust’s NAV fell close to 25%, almost double that of the benchmark (-13.1%).

The reasons for the volatile returns relative to peers and the benchmark are twofold. Firstly, as we discuss in the Portfolio section, the trust has a bias towards small- and micro-cap companies. These are typically hit the hardest in a downturn, but will rise the fastest during a bull market. Secondly, the trust consistently holds high levels of gearing, which can dramatically hinder performance in falling markets. This was seen in 2018, when the trust was geared between 7% and 14% throughout the year.

performance

Source: Morningstar

Returns have continued to be volatile over the past year. The second half of 2019 saw the trust perform strongly, as some of the uncertainty surrounding Brexit and the ongoing global trade wars subsided. However, as one might anticipate, 2020 has hit the trust particularly hard. Year to date the trust has lost 17.9%, in comparison to 16.7% from the benchmark and 10.5% from the AIC peer group. The downside capture over this period has been 113%, in comparison to the sector average of 96%. Along with the trust’s aforementioned traits which hinder it in falling markets, the sectoral exposure has also negatively impacted the performance. As we discussed in our recent article, 'The fight in the dog', sectoral allocation has been a key contributor to returns throughout the pandemic. Many of the trust’s largest sector allocations, including financials, energy and communication services, have struggled.

However, Ollie isn’t focussed on the short term and instead is taking quite a contrarian position relative to other managers. He has identified that analysts are favouring companies with strong cash flow and balance sheets, but he thinks that in the post-COVID 19 world there could be reasons to take on companies which have some leverage. This is principally because, from a national perspective, there is an attitude of ‘we’re all in this together’. Therefore, after the crisis has passed, banks are going to be extremely wary of ‘pulling the plug’ on businesses which have struggled as a result of the coronavirus.

Dividend

Although the purpose of the trust is to grow capital, it also pays a dividend. Dividends are paid semi-annually and the one dividend announced so far in 2020 saw an increase from 7.5p to 7.8p. Currently yielding a not insignificant 3.1%, the trust has increased its dividend for the last nine consecutive years, as shown below.

annual dividend

Source: Janus Henderson

Over the past five years this represents a growth rate of 27.6%, comfortably the highest in the sector. Given the current market conditions, it is unlikely that the trust will continue to grow the dividend at this rate. However, the most recent dividend was covered 3.8x by revenue reserves, so TRG should be in a stronger position than other trusts.

Management

Ollie Beckett is the lead portfolio manager of the trust, and is also responsible for Janus Henderson’s open-ended European Focus Fund and International Small Cap Fund. He has 23 years of financial-industry experience and first joined Janus Henderson as an assistant portfolio manager for European equities, before becoming a fund manager in 1999. He left Janus Henderson in 2003, before returning to his current role with the firm in 2005. Ollie is also supported by co-managers Rory Stokes and Julia Scheufler, who have 15 and nine years of relevant experience respectively.

Discount

TR European Growth Trust has seen considerably more discount volatility than its peer-group average over the past five years, as the graph below shows. After an exceptional period of performance in 2018, where the trust ended the year trading at a premium, the discount has widened relentlessly. For much of this time, we think this has likely been due to the uncertainty surrounding European smaller companies and the impact of Brexit, as opposed to the manager’s performance. However, 2020 has seen the trust get hit particularly hard relative to peers and trade on a discount as wide as 23% at times, perhaps due to the high levels of gearing.

Over the past year the average discount has been 13.6%, although currently the trust is trading at a discount of 16.4% (as at 18/05/2020). This is the widest in the European smaller-companies sector, where the average discount is 11.2%.

discount

Source: Morningstar

The board does have a buy-back policy in place should the discount widen sufficiently, but this has not been exercised over the past few years.

Charges

Currently the OCF for the trust is 0.72%, considerably lower than that of every other trust in the European smaller-companies sector (where the average is 0.99%, excluding performance fees). Although TRG has a performance fee, it was not earned last year.

The base management fee for the trust is 0.6% of net assets up to £500m (currently £435m); should the trust exceed this, the manager charges 0.5%. The manager may also charge a performance fee, and the rate is 15% of the difference between the NAV total return and the return of the benchmark. A performance hurdle over the benchmark of 1% has to be reached before any performance fee can be earned.

The KID RIY for the trust sits at 0.72%, relative to the sector average of 1.69%. It is worth noting, however, that calculation methodologies can vary across companies.

ESG

Currently the OCF for the trust is 0.72%, considerably lower than that of every other trust in the European smaller-companies sector (where the average is 0.99%, excluding performance fees). Although TRG has a performance fee, it was not earned last year.

The base management fee for the trust is 0.6% of net assets up to £500m (currently £435m); should the trust exceed this, the manager charges 0.5%. The manager may also charge a performance fee, and the rate is 15% of the difference between the NAV total return and the return of the benchmark. A performance hurdle over the benchmark of 1% has to be reached before any performance fee can be earned.

The KID RIY for the trust sits at 0.72%, relative to the sector average of 1.69%. It is worth noting, however, that calculation methodologies can vary across companies.

Fund History

Related Research

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