Henderson European Focus Trust (HEFT) offers investors a flexible approach to large-cap European equities. The managers, John Bennett and Tom O’Hara, have an investment ‘DNA’ which is composed of six distinct facets, encapsulating both financial analysis and their general philosophy around investing. The team are acutely aware of the need to remain flexible, and avoid becoming married to a single style of investing. They believe that such an approach will ultimately prove of value to HEFT’s shareholders by avoiding prolonged underperformance when a specific style is out of favour. We discuss the investment philosophy of the team in further detail in the Portfolio section.
The team have recently made substantial changes to their portfolio in order to capitalise on the post-pandemic V-shaped recovery across varying sectors. During the second quarter of 2020 the team positioned HEFT to capitalise on the recovery in industrial stocks, foreseeing the rapid revival in industrial output. The team have unwound this trade at the start of 2021, having now positioned HEFT to take advantage of the second V-shaped recovery, this time in consumer-sensitive stocks. The impact of the team’s flexibility is clearly seen in their performance because they have outperformed their benchmark over the long term, and have generated even stronger near-term performance, as we describe in the Performance section.
HEFT currently trades at a Discount to its peers, despite its recent outperformance. We believe this is likely a consequence of investors’ historical avoidance of European equities, rather than a factor unique to HEFT. We also note that HEFT has good ESG credentials – even with its recent allocation to value-oriented stocks – as a result of the managers’ holistic approach to investing.
HEFT offers something we believe is rather rare in either the open- or closed-ended European equity space: a team who successfully incorporate top-down factors in their investment process. In doing so they diversify the source of HEFT’s alpha, offering investors not just successful stock-picking but also a macro overlay which enables HEFT’s style exposures to shift over a given cycle.
In contrast to the vast majority of the European peer group which have a clear growth bias, HEFT offers a differentiated proposition at the current time. In our view, HEFT is currently well positioned as a partial inflation hedge. This is thanks to its increased allocation to financial stocks, lower overall valuation metrics and recent overweight to consumer discretionary stocks (which will likely be the driver behind near-term inflation as demand picks up). As such, and potentially of relevance to the discount, HEFT may be increasingly attractive to investors as the recovery continues if the prospect of inflation continues to raise its head.
In our opinion, the recent performance of HEFT illustrates the potential of having a flexible approach to investing. The team have made decisive moves to position towards industrials first, and then latterly towards consumer discretionary as the recovery took hold. In doing so they have altered the overall style tilt of the portfolio, yet have also successfully generated significant alpha. Such actions are inevitably difficult to time, but we are encouraged not only by HEFT’s recent outperformance but in hindsight also by the timeliness of the team’s trades.
|Flexible investment process that can adapt to changing markets, with strong performance during the pandemic||Active macro allocation decisions add potential timing risk|
|Long-term outperformance from stock-picking||May underperform in the near term if the market quickly reverts to favouring growth over value|
|Currently a very differentiated position relative to the growth-focussed peer group||Allocation to oil majors and cement manufacturers may be unpalatable to investors operating explicit ESG screens|
Henderson European Focus Trust (HEFT) offers investors a portfolio of large-cap European equities, with the sole objective of maximising capital growth. HEFT is run by John Bennett and Tom O’Hara, investment managers at Janus Henderson Investors. The team follow a predominantly bottom-up approach to stock selection, although they remain open to the utilisation of top-down factors (e.g. macroeconomic factors), with an overall philosophy of creating a focussed high-alpha portfolio.
One of the hallmarks of the investment process is that the managers retain the flexibility to allocate to different types of stocks at different points in the cycle, much more so in our view than other strategies within the European sector can (due to the significant growth bias they typically have). The managers’ process not only incorporates conventional financial analysis but also a form of ‘self-reflection’ through which the team aim to identify their own biases and past mistakes. This prevents the team from being married to a single style of investing, with the team intentionally rebalancing HEFT to adapt to the market cycle. The team refer to their overall philosophy as their investment ‘DNA’, and this is made up of six strands:
- Follow the cash
- Avoid excessive leverage
- Believe in change
- Believe in cycles
- Give yourself time
- Be ready to be wrong
The first two components of the team’s ‘DNA’ are more akin to conventional company analysis. The team place a greater priority on companies which are able to generate high and sustainable cash flows, especially those which have a long runway of cash flow growth. This allows their investments to be ‘self-sustaining’ and able to generate growth organically by effectively reinvesting their cash flows, rather than being influenced external factors or market sentiment. The team also actively avoid overly leveraged companies, preferring a company whose cash flow is generated using modest leverage. the mechanisms by which a company can generate strong cash flows can vary for HEFT though, unlike a growth-focused strategy for example, whereby cashflow would grow as a result of company’s aggressive pursuit of sales growth. Instead, the team will often look for changing circumstances as a catalyst for an increase in a company’s cash flow generation. Change can take many other forms, however, with one form being a company’s ability to disrupt an incumbent market. The team also look for change in industries, be it through shifting capacity or industry dynamics (for example, the increasing pressures placed on ESG-poor companies by both markets and policymakers). Change can also be caused by a company-specific factor whereby efficient changes in a company’s capital allocation can increase the free cash flow yield, or as a consequence of a new management teams being brought in, or simply due to the reorganisation of older value-oriented businesses.
The most encompassing form of change is also linked to the fourth strand of HEFT’s investment ‘DNA’: that a company’s return profile can change as a result of market cycles. The team firmly believe that investors need to be able to adapt to changing market environments. In their view, constantly adhering to a single style of investment can destroy value for clients by causing a trust to structurally underperform during periods when that style is out of favour. In order to avoid this the team try to move with the market cycle, identifying prevailing trends by taking account of both top-down and bottom-up analysis. An example of a changing cycle the team have adapted HEFT to is the trend towards expanding multiples, where the team have had to adapt their valuation sensitivity to keep pace with the broader expansion of price multiples within the market. While the team do change their long-term allocations to align with the market cycle, they are unlikely to make aggressive short-term bets given that ultimately they are long-term stock-pickers. Their long-term view towards investing comes as part of their fifth strand. The team believe that conviction is needed in their investments in order to see an investment thesis play out because change is rarely a rapid occurrence, and therefore they believe they shouldn’t try to generate alpha through risky short-term trading.
While the team do take a patient, high-conviction approach to investing – with 44% of the portfolio being held for over 30 months – they are conscious that the time horizons of their shareholders may not be as long as their own. Thus, they remain conscious of the occasional need to temper their holding periods at times to avoid prolonged underperformance which may not be palatable to their investors. The final aspect of their ‘DNA’ is the team’s own acknowledgment of their capacity to make mistakes, stemming from their belief that no one single style of investing continually adds value to shareholders. As a result of this, the team view even their own investment process as more of a framework and less of a ‘religion’, given their desire not to box themselves in. In their own words, they “resolutely refuse to become ardent, inflexible ‘style’ managers”.
HEFT’s portfolio has become increasingly concentrated over the years. When inherited by John Bennett in 2010, it was not uncommon to see the portfolio stretch to 100 names. Today the mandate is for up to 45 stocks the maximum number of holdings having been reduced from 60 after the motion gained approval at the 2020 AGM. HEFT’s allocation is not benchmark-driven in any way and is largely only a reflection of which names the team have the highest conviction in, although allocation is subject to adequate diversification. The Trust rarely holds individual stocks at greater than 5% of NAV, although the managers are prepared to do so for particularly high conviction positions. This is currently the case for the two largest holdings Holcim and UPM Kymmene.
While the team incorporate top-down analysis and thematic market trends in their assessment of a company, it is uncommon for them to make overall sector calls, with each individual company being selected on its own merit. As we show in the chart below, the portfolio’s sector allocations differ markedly to those of the benchmark. HEFT’s investible universe is essentially that of the STOXX Europe 600 Index, and an important part of the investment process is the initial filtering down of this universe. The team believe that knowing what to avoid is just as important as knowing what to purchase. They will utilise their knowledge of prevailing economic and market trends, as well as their requirement for cash-generative and low-leveraged businesses, to filter down this universe.
sector allocation against benchmark
The team have seen opportunities for two broader thematic trades due to the COVID-19 pandemic. The first occurred in Q2 2020, where the team observed that industrials had been oversold during the market crash. The team foresaw a V-shaped recovery from the pandemic, with industrial production quickly recovering post-lockdown. The team would hold this belief throughout most of 2020, allocating to companies in the industrials sector while also adding to their existing ‘value’ stocks. This latter action was an example of a rare sectoral bet whereby the team increased their allocation to banks, automobile manufacturers and oil producers, as the team believed that like their industrial stocks these sectors had in aggregate been oversold, and were primed for a rapid recovery in their share prices when the global economy normalised. The team highlight that banks, in particular, are primarily a play around improving macroeconomic indicators, as well as an option on the potential increase in inflation resulting from the economic recovery. HEFT currently has its largest overweight to the materials sector; however, this is the result of stock selection rather than an outlook on the sector, as the overweight has been achieved through large positions in a handful of stocks. These include HEFT’s top two holdings: Holcim, the cement manufacturer, and UPM-Kymmene, the pulp, paper and biofuels producer.
top ten holdings
|LVMH Most Hennessy Louis Vuitton
Source: Janus Henderson, as at 30/04/2021
Since Q4 2020 the team have made further changes to the portfolio. By the start of the year they believed that the recovery in industrial stocks was maturing, as the market began to price in a return to economic normality thanks to the vaccine roll-out. However, at the same time they saw the potential for another V-shaped recovery, this time in consumer-sensitive sectors such as luxury goods, air travel and brewers. With the advent of loosening lockdowns across Europe, as well as the broader increase in consumer demand across the world, the team believe that consumer discretionary companies have a more promising outlook than that priced in by the market, and that like the industrials sector, they too will quickly recover from their pandemic-induced lows. Thus, the team initiated new positions in companies like Adidas, the sporting goods manufacturer, and Ryanair, the low-cost airline. They have also been increasing their pre-existing holdings in consumer-sensitive companies such as LVMH and L’Oréal. However, the team retain their allocations to value stocks, believing they still have further to go in their recovery.
It is worth noting that HEFT will never have an innate style bias, but that the team may intentionally tilt towards a specific style at particular times in the cycle. As such, investors should be aware that whilst the current stylistic position of HEFT means that it is very different to the rest of the European investment trust sector peer group (which has a heavy bias towards growth), this may not always be the case. HEFT has a current tilt towards value which shows up when we compare the portfolio metrics to the benchmark, and this is a result of the team’s tactical positions around the recovery in banks, automobile manufacturers and oil majors. This can be seen in the below table, with HEFT’s valuation ratios below those of its benchmark, the FTSE World Europe ex UK Index. HEFT also has varying quality metrics, while its holdings generate slightly lower returns on their equity (one of the defining differences between value and growth stocks). HEFT’s portfolio also has lower debt than the benchmark, as per the team’s investment process. In our view, an interesting consequence of the current positioning of HEFT is that it should act as a partial hedge against inflation and rising interest rates, should those occur. This is due to the team’s investment in financials, which benefit from a rising rate environment. It is also because of the recent overweight to consumer discretionary, a sector whose increased demand post-pandemic will be a primary driver of inflation in Europe, and therefore this sector should be an indirect beneficiary of rising inflation. HEFT’s lower valuation ratios in comparison to the benchmark will also reduce the portfolio’s overall interest rate sensitivity, as there is lower opportunity cost associated with holding the portfolio during a rising rate environment.
|PRICE||FYQ P/E (future)||16.4x||17.7x|
|One-year earnings growth forecast||37.8%||30.3%|
Source: Janus Henderson
HEFT does not currently utilise any gearing and has historically made little use of it, with the trust’s five-year average gearing level of 0.9% reflecting the cautious nature of the managers. Unfortunately HEFT was c. 2% geared going into the COVID-19 crash during Q1 2020, and as such the use of gearing was an overall detractor for the 2020 financial year (ending 30/09/2020). Since September 2020 the team have utilised less than 1% gearing. HEFT is able to utilise gearing up to 20% of NAV at the time of borrowing, and this is achieved through a £46.8m multicurrency debt facility with HSBC.
We believe that HEFT has shown good performance over the last five years, where it has generated an NAV total return of 87.4% and a share price return of 83.6%, beating the 76.5% return of its benchmark the FTSE World Europe ex UK Index (proxied by an ETF here). However, HEFT has underperformed its peer group over the same period, which generated a NAV return of 92.9%. Much of HEFT’s outperformance against its benchmark has been the result of the team’s successful stock-picking, as opposed to utilising increased sensitivity to the market or overweight exposure to growth. This is a fact which is supported by HEFT’s risk stats, where the NAV has a five-year beta of 1.02 and R² of 95.9 (indicating HEFT’s close correlation with the benchmark), with HEFT also having an annualised alpha of 1.46 and an information ratio of 0.5 (whereby positive numbers for both statistics demonstrate successful stock selection and thus value-add by the managers). While HEFT has marginally higher volatility than its benchmark (at 13.8 versus 13.7 over the last five years), this is more than made up for by the trust’s superior return profile, with HEFT’s Sharpe ratio of 0.66 exceeding its benchmark’s 0.59.
Past performance is not a reliable indicator of future returns.
As can be seen by the below discrete annual returns, HEFT has largely been successful in navigating the varying market environments, having outperformed its benchmark in seven of the ten periods. The team are aware that their approach means the trust will not beat its peers or benchmark in every period. While they aim to steward HEFT through the evolving market environment, it remains a stock-picking portfolio and there may be periods in which HEFT’s holdings underperform as the team wait for their investment thesis to play out. It is important to note that while the team aim to retain flexibility in their approach, they will not sacrifice their conviction in their underlying holdings in order to rotate the portfolio for short-term changes in the market, and will tolerate short-term underperformance so long as it is conducive to adding value for their shareholders in the long term.
discrete annual performance
Past performance is not a reliable indicator of future returns.
The last 12 months have been an excellent example of the team’s effective stewardship of the portfolio and have shown the advantages of a flexible investment process. For the 12 months up to 31/05/2021, HEFT generated a NAV total return of 31.3% and a share price return of 41%, far in excess of the 25.3% of its benchmark and ahead of the 29.3% NAV total return of its peers. This outperformance is the direct result of the team’s active allocations around V-shaped recoveries in industrials and consumer sectors, as well as their increased weighting to value stocks. The performance stats also support this notion, as over the last 12 months HEFT has been able to generate an upside capture ratio of 107% compared to the 102.3% of its peers, while not having taken on any additional downside risk given HEFT’s downside capture ratio of 79.3% compared to the peer group’s 79.8%.
Past performance is not a reliable indicator of future returns.
Though the team clearly have a bullish view around the near-term recovery in Europe – and in particular around the rebound in consumer-sensitive stocks – they highlight that over the medium term we are likely to return to an environment in which successful stock-picking is more conducive to returns than thematic or stylistic bets. This is due to the momentum resulting from the varying cycles of the pandemic dissipating as economies normalise. After such a time we are unlikely to see the same clear winners as we did during the pandemic (such as the surge in demand for technology stocks), and it is more likely stock-specific factors will predominantly drive shareholder returns. The team do highlight that there are certain macroeconomic outcomes which will act as headwinds for specific styles, with the possible rise in inflation being one of them. If we see a return to an inflationary environment post-COVID-19 then it is likely to prove a headwind for interest-rate-sensitive growth stocks. As we note in the Portfolio section, the team have already positioned HEFT for such an outcome.
HEFT’s primary objective is that of capital growth, and as such it will not jeopardise total returns in order to facilitate a dividend payout. That being said, we understand that the board is mindful of the benefits the trust structure brings to dividends and will aim to pay out a dividend which the board feels is appropriate. In the 2020 financial year HEFT paid a total dividend of 31.3p per share, maintaining the 2019 pay-out. The board was forced to tap into HEFT’s revenue reserve to maintain this payout, the second year in a row that the board has paid an uncovered dividend. By our estimates HEFT has a revenue reserve coverage ratio of 1.1 times, meaning the board still has plenty of flexibility in this regard.
The team are quietly confident in the future near-term dividend profile of their portfolio. Their increased allocation to banks, which may soon see dividend suspensions lifted, as well as their increased allocation to higher-yielding value sectors, should strengthen the near-term revenue generated by the trust.
dividend and revenue per share
HEFT has been managed by John Bennett since December 2010, and Tom O’Hara joined him as co-manager in January 2020. The duo sits within Janus Henderson’s pan-European equity team. John leads the style-agnostic allocation within European large caps, where he also manages the Janus Henderson Continental European and Pan European long-only and long/short strategies, making him responsible for €6.8bn in assets. He has held these roles since 2011 when Gartmore, where he worked previously, was acquired by Janus Henderson. Before Gartmore, John served as a fund manager at Global Asset Management for 17 years. During this time he managed the firm’s flagship European long-only and European equity long/short hedge funds. John has a total of 34 years of industry experience.
Tom O’Hara is a portfolio manager at Janus Henderson Investors, a position he has held since 2020. He co-manages the Concentrated Pan Europe Equity, Continental Europe Equity, Pan Europe Equity and Concentrated Continental Europe Equity strategies. Before joining the firm as a research analyst in 2018, Tom was an equity research analyst specialising in metals and mining with Exane BNP Paribas from 2016. Tom has 15 years of industry experience.
HEFT currently trades on a 7.8% discount, wider than the 5.7% simple average discount of its peers. We believe that HEFT’s discount is the result of two factors. The first is the aversion investors have shown European equities over recent years, with six of the eight trusts in the AIC Europe sector currently trading on a discount. As a region, Europe has underperformed US equities for most of recent memory, with the lack of investor demand for funds which are exposed to the region often reflecting this. The other factor is more unique to HEFT, whereby the trust’s flexible approach has led to it not having a clear quality growth bias, a style which has been associated with outperformance over recent years. We observe that the two trusts in the peer group which trade at a premium to NAV have clear growth biases.
If the team can sustain their recent outperformance until the market environment becomes more favourable to flexible stock-picking than trend investing, we believe that there is clear potential for HEFT’s discount to narrow. In our view, Europe is a target-rich environment for stock-pickers, and so HEFT’s attractions should come to the fore. The board operates a discount control mechanism with the capacity to repurchase shares when HEFT trades at a discount, but with no hard targets. Over the last 12 months 115,000 shares have been repurchased, representing 0.5% of the current shares in circulation. The most recent repurchase was made in September 2020, when HEFT traded on a 13% discount.
Past performance is not a reliable indicator of future returns.
HEFT has a current OCF of 0.86%, marginally below the 0.87% simple average OCF of its peers. HEFT uses a tiered management fee, whereby it charges 0.65% on assets up to £300m and then 0.55% thereafter. We estimate that HEFT has a current management fee of 0.63%, based on a current NAV of £367m. By utilising a tiered management fee structure HEFT’s OCF should fall as the NAV of the trust grows. The annual management fee and interest rate charges are 75% to capital and 25% to revenue.
HEFT has a KID RIY of 1.34%, compared to the 1.27% simple average of its peers. However, we would highlight that calculation methods can vary between trusts.
While HEFT is not an explicitly ESG-aligned trust, we understand that the team fully incorporate ESG analysis into their investment process. The team take a pragmatic view on ESG analysis, reflecting the overall flexibility of their investment process, and believe that companies will ultimately be rewarded for having strong ESG credentials. Having foreseen the rise in sustainability initiatives such as the Next Generation EU green recovery fund and the increasing demand for associated solutions, the team first invested in the renewable utility sector at the start of 2020.
That said, the team are nonetheless conscious of the pitfalls of investing in companies which appear to rank highly on ESG credentials based on assessments by rating agencies. They believe such companies will already have the benefits of good ESG credentials fully priced in, and that by investing in already ‘good’ companies they forego the benefits of changes resulting from improving ESG practices. Much like their general approach to investing, the team believe that the most value is in companies with the capacity to change their ESG credentials for the better. To make sure they don’t avoid currently poor ESG companies which are on the path to improvement, the team therefore do not operate an explicit ESG screen. They also do not place too great a weight on quantitative ESG scores in order to avoid having a bias to companies with strong ESG credentials but which offer little upside.
One example of this process has been the team’s holding in ArcelorMittal, the European steel producer. The team highlight that on the surface Arcelor is a poor ESG company, being designated a high ESG risk by Sustainalytics, the ESG rating agency. Yet the team believe Arcelor is a perfect example of a company changing for the better. At a headline level Arcelor has set itself a target of net-zero carbon emissions by 2050, with an interim target of a 30% drop in CO2 emissions by 2030. Arcelor has already outlined two major routes to achieving these objectives in the use of ‘smart carbon’ and the sourcing of its energy from renewable hydrogen. Steel is also an unavoidable part of the transition to a renewable future. Unlike fossil fuels, steel will continue to have a place in the global economy, with the advent of increased investment in renewable infrastructure only increasing demand for it. The team also highlight the increasing overseas demand for European steel, given the lower carbon intensity of its production.
Morningstar rates HEFT’s overall sustainability as ‘average’ when compared to Morningstar’s broader European equity large-cap sector. The fact that HEFT remains in line with the peer group is in our view promising given its recent investments in sectors typically associated with poor ESG credentials such as oil, automobile manufacturers and cement companies. We believe that HEFT remains a compelling option for investors looking for a more value-oriented approach to European equities without having to sacrifice the overall ESG credentials of their portfolio.