The European Smaller Companies Trust: Following returns not the crowd

ESCT’s manager follows the returns not the crowd…by Alan Ray

Overview

European Smaller Companies Trust (ESCT) targets capital growth by investing in small and mid-sized European companies. Over 50% of the portfolio is invested in companies with a market capitalisation of less than €1bn, meaning ESCT has more of a bias to small companies than is average for its peer group. The Portfolio is diversified across c. 130 holdings and is not constructed using a single investment style, with holdings in growth, value, earlier stage, mature and turnaround businesses.

Over the last five and ten years, ESCT has outperformed both its benchmark and peer group, in both NAV and share price terms. Notably, during a five-year period when large caps have outperformed small caps, ESCT has also returned more than the closest equivalent large cap index.

ESCT’s lead fund manager, Ollie Beckett, has been with Janus Henderson since 1998 and has managed the trust since 2011. Ollie is supported by portfolio manager Rory Stokes and associate portfolio manager Julia Scheufler, working within the European equities team. They take a style agnostic approach, investing across quality growth companies, turnaround situations, early-stage growth and more mature companies.

The trust is geared by c. 15%, and this has gradually increased in 2022 as the team see greater opportunities from lower valuations. The current yield is c. 3.3% which is relatively high for a small cap trust, but Ollie is keen to emphasise the main goal of ESCT is capital growth, and while the trust has a long record of progressive dividends, this isn’t the main objective of the trust. ESCT trades on a c. 15% Discount, in line with its peer group, and very recently the board has begun to buy shares back in response to the discount.

Kepler View

We think investors mostly turn to smaller companies for their greater return potential, and accept that they come with more potential risk in exchange. It seems entirely consistent for a small cap manager to begin to increase gearing even as sentiment is very poor after some very tough times that have left small caps on very low valuations. In the Portfolio section we discuss the different categories Ollie and the team use to describe the portfolio, but in summary this is a pragmatic portfolio of small companies not bound by a particular investment style, but going wherever they believe the opportunities might be.

That’s not to say that the team aren’t aware of the risks that small caps come with, and the portfolio is diversified across c. 130 stocks. Although about half the portfolio is in sub-€1bn market cap stocks, there is generally still good liquidity, which means, for example, that gearing can be adjusted dynamically and share buy backs, which the board has just started implementing, can be undertaken without worrying about cash levels.

As Ollie notes, valuations for European small caps are around levels which, historically, have been followed by very strong three- and five-year returns, and while the team spend most of their time thinking about stocks and not macro factors, this is quite a compelling point. We think investors seeking to add some risk to portfolios after an extended period of risk reduction could find ESCT’s diversified portfolio, relatively wide discount and tactical use of gearing very appealing.

Bull

• European smaller companies are close to historical valuation lows which has previously led to strong returns in the following years
• Strong track record even when small caps are out of favour
• Very diverse portfolio limits single company risk

Bear

• Smaller companies are more risky
• Gearing can amplify losses as well as gains
• European economic indicators are very weak

See the full research on ESCT here >

Disclaimer

Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by European Smaller Companies. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.