Investors remain pessimistic over Europe. Outgoing European Central Bank (ECB) president Mario Draghi has just cut the deposit rate to -0.5% (charging banks more to park their money with the ECB) in order to get them to lend while also resuming quantitative easing (QE) to stimulate the economy.

Although sentiment is negative, the positive news for value-oriented portfolio builders is that European stocks look cheap relative to both their own historical levels and global peers.

UNDER-OWNED & UNDER-RESEARCHED

European smaller companies, in particular, could have significant potential upside. This grouping actually outperformed their larger counterparts over the decade to 31 May 2019 and many pay attractive dividends despite their relatively smaller size.

Currently, they remain under-owned and under-researched, shunned by many analysts, fund managers and investors amid much economic and political uncertainty.

Most investors are huddled in the more expensive quality growth and mature parts of the market but one fund willing to venture down the market cap spectrum and put money to work with more adventurous early cycle companies and turnarounds is TR European Growth Trust (TRG).

DEEPLY DISCOUNTED RATING

Seeking capital growth by investing in smaller and medium sized companies in Europe (excluding the UK), the fund is managed by Ollie Beckett, assisted by Rory Stokes and Julia Scheufler.

A true small cap focus differentiates the fund from European trust peers, although income seekers should note TR European Growth pays a progressive dividend and bargain hunters may appreciate a steep 13.1% discount to net asset value (NAV) at the current share price of 883p.

TR European Growth Trust’s shares have de-rated from a previous premium not too long ago with its small cap value style out of favour with investors.

On a 10-year view, the trust’s NAV (total return) has outperformed the benchmark European Euromoney Smaller Companies Index (ex UK) but over the last three and five year periods, performance has disappointed with the trust underperforming the benchmark.

REASONS TO BE CHEERFUL

Lead manager Beckett believes his carefully assembled portfolio has the potential to re-rate, once value investing swings back into fashion, while investors sheltering in the more expensive parts of the market could be in for future disappointments.

‘Weirdly, Europe is the most exposed to global trade,’ he explains. ‘Trump and (China’s) Xi have the punch-up, but Europe feels the pain. The thing that Europe is lacking is fiscal policy.

‘But we are likely to see some fiscal spending which should stimulate the economy and I don’t think it is inevitable we will have recession. And a lot of the cyclical companies, some of which we own, are priced for a recession.’

SEEKING OPPORTUNITIES

Beckett looks to take advantage of depressed valuations in smaller European companies whose growth potential he believes is underappreciated by the wider market, although he stresses ‘we’re very much focused on Western Europe’ and ‘the only things we don’t touch are biotechnology or pure (resource) exploration stocks’.

Each year, the TR European Growth Trust team meets hundreds of companies to assess the durability of their business models, quality of management, their growth drivers and catalysts for revaluation.

‘We will do lots of valuation screens and lots of management meetings and calls,’ explains Beckett, proactive in meeting management teams off-diary. ‘If you are someone’s only meeting or call of the day, they tend to be a lot more responsive,’ he points out.

In terms of differentiation to the peer group, Beckett says ‘we will invest in smaller companies than most people, so we get in at an earlier stage, and we will get involved in companies where things have gone slightly wrong and where there is a turnaround and the returns are going to improve.

‘We’re not necessarily buying the best companies in the world because they tend to be valued accordingly. We’re trying to buy undervalued companies where we believe the perception of the market is wrong, something that worked well, until the last 18 months.’

To mitigate stock-specific risk, Beckett runs a very diverse book flush with 143 holdings as at 31 August and the portfolio IS broadly spread by country and industry sector. As opposed to the open-ended fund structure of unit trusts, one key benefit of the closed-ended structure of an investment trust is that the managers don’t have to sell good companies in falling markets in order to meet redemptions, where investors ask for their money back.

This means Beckett can be patient, using current pessimism to pick up mispriced companies that have strong structural growth or self-help characteristics, and which his open-ended competitors may be compelled to sell as investors seek to reinvest funds elsewhere.

WHAT’S UNDER THE HOOD?

Top 10 positions as at 31 August included Dutch-based wealth manager Van Lanschot Kempen, the German non-prescription drugs company Dermapharm, and Danish ferry and shipping company DFDS, ‘the ultimate Brexit stock’ according to Beckett, being one of two Dover-Calais ferry operators.

Other holdings include Paris-based Nexans, a maker of cables for construction, telecoms and high-voltage power lines and GTT, the market leader in liquefied natural gas (LNG) container liners. It is growing off the back of the decline of the nuclear industry and China’s environmental push involving a switch from coal to gas.

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