European Smaller Companies 20 May 2020

TR European Growth Trust (LON:TRG) aims to deliver capital growth by investing in smaller and medium-sized companies in Europe (excluding the UK). It tends to own smaller companies, on average, than the majority of its peers and pursues a contrarian valuation driven approach which sees it more highly exposed to ‘value’ plays than others in the sector.

With a strong record of dividend growth, the trust offers a solid yield, and is insulated from the threat of dividend cuts by a large revenue reserve. Though well diversified, the trust’s high gearing and preference for smaller, often out-of-favour, companies has meant significant volatility for investors. Ollie Beckett has been running the portfolio since 2011, utilising a bottom-up approach to stock selection. The investment process differentiates the trust from others in the sector, as it involves assessing companies based on the stage of their life cycle as opposed to by sector or geography. Depending on where each company sits in its cycle, Ollie will assess different attributes, valuation metrics and sell signals to understand if it is intrinsically undervalued.

The trust is well diversified with close to 150 stocks, and the top ten holdings make up less than 20% of NAV. There is an emphasis towards small- and micro-cap companies relative to peers, with the average market cap in the portfolio £916m, in comparison to the AIC European Smaller Companies sector average of £1.69bn. Ollie pursues a contrarian approach, looking for undervalued companies which he believes are misunderstood by the market, and has been increasing his exposure to companies with leverage throughout the pandemic.

Typically, the trust has outperformed in rising markets but done little to protect capital during falling markets. This is primarily due to the type of company Ollie invests in, as well as the high levels of gearing employed (currently 11%). Over the past five years the trust has delivered NAV total returns of 32.4%, outperforming the benchmark but underperforming the AIC European Smaller Companies sector.

Currently the trust is trading at a discount of 16.4%, the widest in the sector.

TR European Growth Trust looks unlike other trusts in the sector because of its unique investment process and its high exposure to ‘value’ stocks. Through looking at companies based on the stage they are at in their life cycle, Ollie has built a portfolio with a highly differentiated blend of stocks at different stages of their growth trajectories.

The high levels of gearing the trust employs have meant that the trust’s performance has often risen or fallen at a much greater rate than the benchmark or peer group. Interestingly, despite the focus on stages of growth and the small- to micro-cap focus tilt, the trust has higher-than-average levels of exposure to ‘value’ stocks. This has further increased throughout the pandemic, as Ollie looks to take advantage of companies whose leverage means they are being hit particularly hard. Although a risky strategy, the highly diversified nature of the portfolio offers a degree of reassurance.

Although capital growth is the main aim for the managers, the yield of 3.1% is also attractive. Investors should be aware though that dividends will still likely be cut in European smaller companies, though in this scenario the trust’s large reserves put it in a stronger position than most.

The current discount (16.4%) could be an attractive entry point into the trust for those who believe the worst is behind us and a recovery awaits. However, the characteristics described above – and particularly the gearing, at a trust level and in the underlying holdings – could prove troublesome should we see continued lockdowns through Europe.