Henderson European Focus Trust 07 September 2022

Under the guidance of its fund managers Tom O’Hara and John Bennett, Henderson European Focus Trust (HEFT) follows a long-term, bottom-up approach to large and mid-cap Continental European equity investing with a process characterised by style agnosticism. The managers ignore shorter-term fluctuations in investor opinions and style tailwinds, and instead account for fundamental strength, be its strong balance sheets, or cash and revenue outcomes. The team’s ability to foresee positive ‘changes’ to companies, even in unloved sectors, is a constant feature of HEFT.

The HEFT team’s process has demonstrated long-term value creation, but it is its recent performance which has arguably benefitted most from its balanced stylistic exposures, and HEFT has generated substantial 12-month outperformance relative to the AIC Europe sector average, as well as also beating them over a five-year period. HEFT has also remained competitive relative to its benchmark, the FTSE World Europe ex UK Index, over both a five- and one-year period. Over the long run HEFT has demonstrated strong downside protection relative to its peers.

Thanks to the substantial turmoil in European equity markets over the last six months, Tom and John have been able to initiate a number of new positions at attractive valuations, in both traditional growth and value sectors. The largest change has been the managers’ purchase of a range of oil and gas companies. We outline the rationale behind these purchases, plus the HEFT team’s general investment philosophy, in the Portfolio section.

Over 2022 the trust has taken on structural gearing equal to 8% of NAV at the time of writing, which has been used to finance the oil and gas purchases. HEFT trades on a historically wide discount of 14.7% at the time of writing and the board have recently resumed buying back shares.

We believe that Tom and John’s approach has been increasingly vindicated in recent months. Their caution around being overly exposed to factor biases has been an advantage for shareholders, as HEFT has not seen the same painful drawdowns that many of its peers have. Meanwhile, HEFT’s managers’ belief that the market was taking a naïve, broad-brush approach to ESG looks sensible in light of the European energy crisis. Formerly ‘cancelled’ sectors like oil production are now considered investable and, thanks to a lack of capex and competition, remain undervalued relative to the essential role they play in meeting today’s energy demand.

HEFT’s discount, which is wide in both historical and relative terms, offers investors a cheap way to access what is a portfolio of relatively attractively valued equities versus the peer group norm (as determined by Morningstar). We believe this may be attractive to investors who want to limit their exposure to valuation risks, as well as to investors who are concerned about the impact of long-term inflation. This is because a more valuation conscious portfolio could be better placed to capitalise on the winners in an inflationary environment, while mitigating the risk of multiple compression in the more expensive growth stocks. We also note that HEFT’s newly implemented gearing has been deployed into a market downturn, which means it stands to do well if markets rally.

We believe the combination of a valuation-conscious portfolio, structural gearing and a wide discount may prove a powerful catalyst to improving HEFT’s shareholder returns, even if inflationary pressures continue in the near term.