European Smaller Companies 27 September 2024

The European Smaller Companies Trust (ESCT) is managed as a diversified portfolio of European small- and mid-cap companies. The portfolio typically biases towards the smaller end of the market-cap spectrum compared to the benchmark index, which is where the team often find the most under-researched opportunities. The portfolio is broadly diversified across c. 130 positions. There is no specific investment style, with the managers using four broad categories, early-stage growth, quality growth, mature and turnaround, to describe the different businesses they invest in.

Lead manager Ollie Beckett, who has managed the trust since 2011 and been part of the team since 2005, has a strong track record against the benchmark and peer group since his appointment and over the short and medium term. Ollie and the team have believed for some time that European smaller companies are undervalued compared to history and to large-caps, as part of the market dislocation caused by higher inflation and interest rates. While they sensibly don't try to pin a time frame on a recovery, the performance of their companies and signs that the IPO market is restarting are positive signals that investor risk appetite may return.

The trust is geared c. 11% (see Gearing section), which supports the manager's generally positive view for the medium-term outlook for the portfolio. ESCT has a yield of 2.7% and has increased its dividend for several years, although as we discuss in the Dividend section, its primary goal is capital growth and underlying revenue can vary significantly.

The board has used buyback powers from late 2023 and through 2024, and ESCT has seen its Discount narrow slightly during 2024, and currently sits at c. 11%. The trust has a 'backstop' continuation vote in 2025 and every three years.

Ollie Beckett summarises the situation as, “Everything has moved to the right”, which in the current febrile political environment in Europe, could be, and maybe is, an amusing pun, but he's simply referring to the x-axis of time, as the valuation gap between small- and large-cap equities in Europe , persists, and while some of the factors that might help close that gap, falling inflation and interest rates, are falling into place, investors still appear to be climbing the wall of worry, and holding off from chasing the valuation gap. This downbeat assessment modestly ignores that ESCT has not only outperformed its peer group and benchmark, but also the equivalent large-cap benchmark. We look at the numbers in the Performance section.

On the ground, the team see some signals that things are picking up. For example, they have bought into some IPOs recently, finding that the first IPOs after a long hiatus are both very high quality companies and priced for a successful IPO. They are also finding opportunities in the niches that smaller companies can occupy, for example automotive paint systems, that elude large-cap managers feeling miserable about the state of the European car industry. Or in other words, even when the macro doesn't look that enticing, there are still smaller companies that can make money.

The attractions of smaller companies have been a running theme for Kepler for a couple of years now. That might seem like a long time, but it's really the blink of an eye for a long-term investor and ESCT remains an excellent way to play this large but under-appreciated corner of the market.