European Assets 23 November 2020

European Assets Trust (EAT) looks to generate long-term capital growth by investing in a concentrated portfolio of small- and mid-cap companies in Europe (excluding the UK). Income is an important component of EAT’s total return and the board has adopted a high distribution policy, meaning that 6% of the net asset value (NAV) is paid out to investors over each financial year, from capital when necessary.

The trust is managed by Sam Cosh (lead manager) and Lucy Morris, who employ a quality growth approach where that growth has to be bought at what they deem to be a reasonable price. The aim is to be highly active and concentrated, with minimal attention paid to the benchmark.

As we discuss in the Portfolio section, the managers’ conservative approach to valuations resulted in the trust having cash in the portfolio and no gearing when the COVID-19 pandemic and policy response caused a sharp decline in European equities. Going into the crisis they initially reduced risk and increased liquidity further by selling some economically sensitive stocks and some financial holdings. The subsequent speed of the market decline created an opportunity to reinvest this cash into a number of good businesses at what they deemed exceptionally attractive prices. The result of this has been a portfolio with higher-quality characteristics and improved performance, as we discuss in the Performance section.

Currently, the discount sits at 10.3% in comparison to a sector weighted average of 10.9%. This is the second-narrowest discount in the AIC European Smaller Companies sector, but considerably wider than the trust’s five-year average discount of 4.4%.

EAT offers one of the most attractive yields in the European sectors, with 6% of the NAV paid out annually. Due to the capacity for this to be paid from capital, the trust is not dependent on earnings like most trusts and as such could perhaps be considered likely to be more reliable for income-dependent investors. Alongside this, due to the underlying income coming from smaller companies and not from the usual companies or trusts, EAT can be seen as a diversifier and can be used in conjunction with larger-cap trusts.

The outlook for Europe is cloudy, with COVID-19 and the Brexit outcome current concerns. However, the managers’ focus on quality should leave the trust in a stronger position than most. As we discuss in the Portfolio section, the average company in the portfolio boasts higher returns on equity and gross margins, along with considerably less debt relative to the index. The majority of the companies in the portfolio have sound balance sheets and should weather uncertain conditions much better than their counterparts. This has been reflected in the turnaround in performance this year, with the trust delivering returns in excess of the benchmark throughout the volatility of 2020.

We believe the trust has a number of catalysts that could mean we will see its discount of 10.3% narrow significantly, including the combination of improved performance, high dividend yield of around 6% and increased investor enthusiasm for European equities.