European Assets Trust (EAT) offers investors a concentrated portfolio of European small and mid-sized companies, with an objective of maximising total return. Led by lead manager Sam Cosh, who is supported by Lucy Morris, EAT follows a bottom-up process where companies are selected through analysis of their financials, management and fundamental growth trajectory (a combination of sectoral themes and competitive advantages).
Being a bottom-up strategy, macroeconomic factors play no role in the team’s decision-making, with a company’s quality and growth profile being the overriding considerations. The team are also highly sensitive to the valuations of their holdings, seeking to ensure that the portfolio is not one of ‘growth at any price’. We outline their investment process in full detail in the Portfolio section.
While the portfolio is typically one of low turnover, 2020 saw a period of unusual trading activity as the team used the market crash to enter into new holdings at what they identified as very attractive valuations. These trades have been a major contributor to EAT’s recent outperformance, while EAT has also demonstrated strong outperformance over ten years, as we outline in the Performance section.
EAT continues to trade at a discount, albeit one which is narrower than its sector average, and the trust’s discount is currently 8.5%. EAT also offers an attractive dividend profile, paying out 6% of its NAV over the financial year, by tapping into both its income and capital reserves. This has led to it having the highest yield of any trust in both the AIC European Smaller Companies and AIC Europe sectors.
EAT’s managers have demonstrated success as stock-pickers in their small-cap universe. Due to the number of under-researched companies, there is clear potential for active management to add value. Given the high active share and primarily stock-driven returns, we think investors can view this portfolio not only as a source of alpha, but also as a diversifier to most pre-existing European allocations.
We also view the income profile of EAT as attractive, with the dividend paid from capital. This is not only due to its market-leading yield, but also because of the underlying nature of the portfolio. We think it will remain unlikely that an income-orientated investor would be able to find another quality growth portfolio with a similar yield, given the low income typically associated with the sector.
Yet as a result of EAT’s sector and style agnosticism, as well as its strict approach to valuations, there are clear market environments where the trust will underperform. This will most likely be the case during momentum- or trend-driven markets. Similarly, if we were to see a prolonged period of recovery in value stocks, then we think EAT would be unlikely to fully capitalise on the resulting market rally.
Despite EAT’s long-term performance and examples of successful stock picking (as demonstrated by the team’s COVID-19 trades), the shares continue to trade at a discount to NAV. With potential incoming tailwinds for Europe such as the vaccine roll-out and fiscal stimulus, there are potential catalysts for the discount of the sector and of EAT to narrow.
|High active share and stock-selection-driven returns offer source of diversification
||Could underperform in factor-driven markets, e.g. value stock recovery
|Highest yield in both Europe and European Smaller Companies peer groups
||Valuation sensitivity can hinder returns during periods of strong price momentum
|Good long-term track record
||Small-cap investing is historically associated with enhanced volatility