Making changes but keeping successful approach

TR European Growth Trust 3 December 2021 Review
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TR European Growth Trust

Making changes but keeping successful approach

Investment trusts
European smaller companies

3 December 2021

Price

1,400.0p

Market cap

£701.5m

AUM

£834.0m

NAV*

1,601.7p

Discount to NAV

12.6%

*Including income. As at 1 December 2021. NAV is xd.

Yield

1.8%

Ordinary shares in issue

50.1m

Code/ISIN

TRG/GB0009066928

Primary exchange

LSE

AIC sector

European Smaller Companies

52-week high/low

1,535.0p

1,197.5p

NAV* high/low

1,752.1p

1,329.2p

*Including income

Gross gearing*

10.0%

Net gearing*

10.0%

*As at 31 October 2021

Fund objective

TR European Growth Trust seeks capital growth by investing in smaller and medium-sized companies that are quoted, listed or have operations in Europe (excluding the UK).

Bull points

TRG’s robust and differentiated investment process has produced solid long-term outperformance of its benchmark.

Changes arising from the strategic review could attract a broader audience, helping to narrow the discount.

The European small-cap space is home to many companies with positive ESG characteristics.

Bear points

TRG’s valuation-aware approach has been out of favour versus more high-growth peers.

Smaller companies can be less liquid and more volatile in unfavourable market conditions.

There is no guarantee that the new initiatives will cause the discount to narrow.

Analysts

Sarah Godfrey

+44 (0)20 3077 5700

Mel Jenner

+44 (0)20 3077 5700

TR European Growth Trust is a research client of Edison Investment Research Limited

TR European Growth Trust (TRG) is looking to attract a broader investor audience through a range of changes announced after a recent strategic review. The board hopes the change of name (due in January 2022) to The European Smaller Companies Trust will make TRG’s investment focus more explicit, while an eight-for-one share split (due on 13 December) should boost liquidity and help attract smaller regular savers on retail platforms. A reduction in the base management fee (already in place) will benefit existing as well as new investors, while a new benchmark (from 1 July 2022) is more of an administrative issue. The successful investment approach, mainly targeting capital growth from attractive but undervalued growth companies, as well as the management team led by Ollie Beckett at Janus Henderson Investors, remain unchanged.

Fund manager video: Ollie Beckett rounds up the latest TRG developments

Source: Janus Henderson Investors. Note: Information correct at time of filming.

Why invest in European small cap now?

Europe – particularly in the small and mid-cap arena – is seen as a geared play on the global economy, with many innovative companies helping to provide solutions in areas such as manufacturing, healthcare and technology (including e-commerce). While potentially vulnerable in the short term to renewed COVID-19 worries driven by a return to lockdowns and the emergence of a new variant, there is still pent-up global recovery potential to help drive demand for European goods and services.

The analyst’s view

TRG’s new name will solve two problems: it explicitly mentions smaller companies, thus making the investment focus clearer, and omits the word ‘growth’, which has come to be associated with a particular style of investment not shared by TRG, rather than the real-world prospects of its underlying holdings. TRG is the purest-play small-cap fund in its sector, where most peers are skewed more towards mid-caps, and its solid long-term performance record (ranking second in its peer group over one, three, five and 10 years) validates the investment team’s quest to find growing companies across four ‘lifecycle’ segments (early cycle, quality growth, mature, turnaround) where market misperception has led to attractive valuations. We hope to see the discount to NAV (currently 12.6%) narrow as a result of the board’s initiatives and the manager’s continued focus on mispriced growth.

Four main outcomes from TRG’s strategic review

During 2021, TRG’s board conducted a strategic review with the aim of understanding how to maximise the trust’s appeal and ensure it is well positioned for future success. The review focused on the trust’s investment objective, operations and positioning in the market. The board concluded that the investment objective and policy remained fit for purpose and that Beckett’s team and Janus Henderson were doing a good job in terms of implementing it. However, the review has resulted in several recommendations that the board sees as key in boosting private investor ownership, which could be an important lever in narrowing the trust’s discount to net asset value (NAV), given retail investor money tends to be more ‘sticky’ and long term, often supported by regular monthly savings. The main developments are as follows:

Change of name to The European Smaller Companies Trust: TRG intends to change its name with effect from 10 January 2022. The purpose of this is to make the investment strategy more immediately clear to potential investors. When TRG was launched, in fund marketing terms ‘growth’ was seen as the opposite of ‘income’, rather than the opposite of ‘value’ as is more common these days. Hence ‘European Growth’, as well as not signposting the small-cap mandate, could be seen as implying quite a different approach from Beckett’s mantra of ‘trying to buy undervalued companies where the market perception is wrong’. Given the trust had never adopted the Janus Henderson name despite having been under the Henderson umbrella since 1992 (when Henderson bought its original manager, Touche Remnant), the simplicity of the new name allows the trust to ‘do exactly what it says on the tin’, as well as future proofing it against potential corporate changes in years to come.

Eight-for-one share split: in common with many trusts whose share prices have consistently been above £10, TRG plans to subdivide its share capital, although the board has chosen to split each existing share into eight new ones, rather than the more usual five or 10. Following shareholder approval at the AGM, this is set to take place on 13 December. A lower share price could boost trading liquidity and may help to attract regular investors, who might be setting aside as little as £50 a month; at the current share price of £14, a £50 contribution would buy only three shares with £8 remaining uninvested, whereas at 175p (£14 divided by eight), £50 would buy 28 shares, with only £1 left over.

Management fee reduction: the base management fee paid to Janus Henderson Investors has reduced from 0.60% on the lowest tier of net assets to 0.55%. However, the point at which the second tier (on which fees will reduce to 0.45% from 0.50%) kicks in will increase from £500m of net assets to £800m. We assess the likely impact of the changes in the Fees & charges section on page 12. The performance fee calculation basis remains unchanged.

Change of benchmark to MSCI Europe ex-UK Small Cap1: in recent years, ownership of the Smaller Europe ex-UK Index that TRG (and most of its peers) uses as a performance benchmark has moved from HSBC to Euromoney and then to EMIX, which is now part of IHS-Markit. The latest change has affected the availability of timely and reliable index data, so with effect from 1 July 2022 (the start of FY23), the benchmark will change. The reason for the delay in implementing the official switch is so that the old benchmark will remain in place for the whole of the FY22 performance fee calculation period. The MSCI index will not be used on a backward-looking basis to assess performance for any period in which the EMIX index is still the official benchmark. There is a high degree of commonality between the components of the two indices, although the MSCI index contains fewer stocks than the EMIX index (at c 1,400 versus c 2,400), suggesting some of the smallest stocks in the current investment universe may not be present in the new benchmark.

Please note that we have adopted the MSCI Europe ex-UK Small Cap Index in our performance comparisons with effect from this note. This is as a result of a change in the availability of the EMIX index data.

The fund manager: Ollie Beckett and team

The manager’s view: Cash flow is king

Looking at TRG’s benchmark-beating 12-month NAV performance in the context of a market that has gyrated between ‘value’ and ‘growth’ styles, Beckett argues that valuation still matters. ‘At the end of last year after the first vaccine trials were successful, our performance was very good – the world was looking towards increased US infrastructure spending and the hope of a post-COVID economic recovery, so there was a shift towards value and cyclicals and we did better,’ he explains. More recently, with higher inflation fears, recession worries and a flattening of the yield curve, the manager says ‘growth at any price’ stocks have been going up and up again. However, Beckett says, ‘we are not chasing stocks on 60–70x P/E, and we are not assuming discount rates of 1–2% to make high valuations stack up’.

The manager notes that the valuation disparity between the cheapest and most expensive deciles in European small and mid-caps (using a number of metrics) has continued to widen, with stocks in the 10th percentile on average trading at a forward P/E valuation 5.5x higher than those in the 90th percentile at end-September 2021. ‘A lot of companies are priced for perfection’, he says, noting that one former TRG holding, Sinch – a Swedish company that operates a text messaging service for clients such as GP surgeries – was at a forward P/E of c 70x before a small sales miss in late October caused its share price to decline by 20% in a single day (it is yet to recover). However, this is not to suggest that TRG only holds companies whose valuations are low: ‘There are names in the portfolio that are on high P/E multiples, but I think the growth justifies it,’ Beckett explains. ‘There is cashflow generation that allows the likes of HelloFresh (on a forward P/E of c 50x) to spend on marketing and thus drive their sales further. Cashflow generation is a key differentiator for us.’

Considering the outlook (although speaking before the emergence of a new COVID-19 variant in Southern Africa rocked markets in late November), Beckett says: ‘Overall I am still pretty upbeat – when you see c 7% earnings growth and 4% GDP growth, it doesn’t stack up – you would expect mid-teens earnings growth in that environment.’ The team remains happy to buy growth at a reasonable price, and does not expect massive interest rate rises to happen in a hurry, particularly in Europe where the inflationary pressure is less than in the United States or UK. ‘We could have a period of significant outperformance if people get a bit more relaxed,’ the manager concludes.

Asset allocation

Current portfolio positioning

At 31 October 2021, there were 134 holdings in TRG’s portfolio, in the middle of the indicative range of c 120–150 and up from 130 a year previously. As a broadly diversified portfolio, the top 10 holdings (Exhibit 1) currently make up just 18.0% of the total (down from 19.0% at 31 October 2020), with only four positions above 2% of the portfolio.

Beckett and the team have been active on the purchase and sales front so far in 2021, partly driven by a high level of merger & acquisition (M&A) activity. Between 1 January and 30 September, 26 new holdings were purchased and 29 were sold, six as a result of M&A bids. Since the end of September, top holding Aareal Bank has also been bid for by a private equity consortium, which if successful would see it too exiting the portfolio. Belgian insulation maker Recticel (the fourth largest holding) has so far rebuffed the advances of Austrian family-owned plastics firm Greiner, whose bid is now being scrutinised by EU competition authorities. Beckett sees the high level of M&A as proof of the value on offer in the portfolio, with private buyers taking advantage of the hesitancy of public market participants to scoop up attractive assets.

Exhibit 1: Top 10 holdings (as at 31 October 2021)

Company

Country

Sector

Portfolio weight %

31 October 2021

31 October 2020*

Aareal Bank

Germany

Banks

2.5

1.9

Van Lanschot Kempen

Netherlands

Banks

2.3

2.5

TKH Group

Netherlands

Electronic & electrical equipment

2.3

1.9

Recticel

Belgium

Rubber & plastic

2.2

1.6

DFDS

Denmark

Industrial transportation

1.7

2.6

eDreams ODIGEO

Spain

Travel & leisure

1.6

N/A

Boskalis Westminster

Netherlands

Construction & materials

1.5

N/A

BFF Bank

Italy

Banks

1.4

N/A

Flex LNG

Norway

Industrial transportation

1.4

N/A

Deutz

Germany

Industrial engineering

1.3

N/A

Top 10 (% of portfolio)

18.0

19.0

Source: TR European Growth Trust, Edison Investment Research, Bloomberg, Morningstar. Note: *N/A where not in end-October 2020 top 10.

New purchases have mainly been in the quality growth segment (12 new holdings), including German online cycle equipment store Bike24, bought at initial public offering (IPO) in June. Also bought at IPO were Grenergy Renovables (a renewables focused utility company) and Apontis Pharma, which makes single-dosage drugs. Both of these are in the early cycle segment, where five new holdings were added, reflecting a smaller number of attractively valued opportunities. Seven purchases were in the turnaround segment, including Barco, a Belgian firm that makes laser projectors for cinemas, webcasts and videoconferencing equipment, which had seen sales growth slow because much of its customer base was working from home. Only two new stocks were added in the mature space, including Swedish medical technology company RaySearch Laboratories.

Cerved, Dialog Semiconductor, Euskaltel, Sbanken, Schaltbau and Tarkett, many of which had been long-term holdings, were exited after takeover bids. However, the majority of sales (16 of the 29) were as a result of profit-taking in positions the team considered to have reached fair value, such as Dermapharm, Embracer, Stratec and Swissquote. Four holdings were exited after their initial investment thesis failed to play out, including krill farmer Aker BioMarine. Finally, three positions were sold in order to take advantage of better opportunities elsewhere.

Exhibit 2: Portfolio geographic exposure (% unless stated)

Portfolio end-October 2021

Portfolio end-October 2020

Change (pp)

Germany

23.7

21.6

2.1

France

12.2

13.6

(1.4)

Sweden

10.5

8.5

2.0

Netherlands

8.2

8.0

0.2

Italy

8.2

8.2

(0.0)

Switzerland

5.8

8.8

(3.0)

Belgium

5.7

3.8

1.9

Spain

5.7

4.2

1.5

Finland

3.9

5.3

(1.4)

Ireland

3.7

N/S

N/A

Norway

N/S

5.0

N/A

Other

12.5

13.0

(0.5)

100.0

100.0

Source: TR European Growth Trust, Edison Investment Research. Note: N/S = not stated; may be included in ‘other’.

As a bottom-up portfolio, TRG’s geographical and sector exposures (Exhibits 2 and 3) are an output of stock selection. However, with stock selection itself predicated on finding attractive companies whose valuations do not reflect their long-term growth prospects, this shows through in the portfolio weightings, with an underweight in Sweden (c 6pp versus the benchmark) because it is ‘expensive’, and a clear preference for more cyclical sectors such as industrials.

Exhibit 3: Sector exposure at 31 October 2021 (IMIC)2

  During 2021 IHS-Markit applied its own industry classification scheme (IMIC) in place of the sectors formerly used by the EMIX indices. This means it is hard to make a year-on-year comparison of TRG’s sector exposures (shown in Exhibits 3 and 4).

Exhibit 4: Sector exposure at 31 October 2020 (EMIX)

Source: TR European Growth Trust, Edison Investment Research

Source: TR European Growth Trust, Edison Investment Research

Exhibit 3: Sector exposure at 31 October 2021 (IMIC)2

  During 2021 IHS-Markit applied its own industry classification scheme (IMIC) in place of the sectors formerly used by the EMIX indices. This means it is hard to make a year-on-year comparison of TRG’s sector exposures (shown in Exhibits 3 and 4).

Source: TR European Growth Trust, Edison Investment Research

Exhibit 4: Sector exposure at 31 October 2020 (EMIX)

Source: TR European Growth Trust, Edison Investment Research

As shown in Exhibit 5, TRG is a true small-cap portfolio, with two-thirds of holdings having a market cap below £1bn. Beckett says he is currently finding stocks in the £800m to £1bn range to be the ‘sweet spot’ in terms of opportunities.

Looking at TRG’s portfolio metrics versus the benchmark, the manager explains that the trust’s higher portfolio yield (2.8% vs 2.5% for the index) reflects its focus on cash-generative companies. The lower forward P/E rating is to be expected in a value-orientated portfolio, although the fact it lies in the mid-teens underlines that the team is not buying ‘deep value’ stocks. While return on equity (at 7.4% vs 8.1%) is lower than the index, Beckett notes that ‘we are looking for an improvement, not an absolute. When you are trying to buy undervalued companies where the market perception is wrong, a pick-up in RoE can be an inflection point.’

Exhibit 5: Market cap distribution and portfolio metrics versus benchmark

Market cap of TRG portfolio holdings (adjusted for gearing)

Valuation metrics of TRG portfolio and EMIX Smaller Europe ex-UK

 

TRG

EMIX index

Dividend yield (%)

2.8

2.5

P/E 12-month forward (x)

14.4

16.1

Return on equity (%)

7.4

8.1

EPS 3-year historical (%)

0.6

3.3

EPS 12-month forward (%)

67.2

33.0

Source: TR European Growth Trust, Edison Investment Research. Note: Data at 30 September 2021.

Performance: Holding steady after impressive gains

Exhibit 6: Five-year discrete performance data

12 months ending

Share price
(%)

NAV
(%)

MSCI Europe ex- UK Small Cos (%)

MSCI Europe ex-UK (%)

CBOE UK All Cos (%)

30/11/17

66.3

39.1

30.5

24.4

13.7

30/11/18

(26.8)

(16.1)

(7.0)

(4.3)

(1.8)

30/11/19

9.3

10.4

12.4

14.1

11.3

30/11/20

32.9

29.1

15.7

7.1

(11.2)

30/11/21

18.6

21.8

20.8

15.5

17.1

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

For FY21 (ended 30 June), TRG posted NAV and share price total returns of +63.5% and +79.5% respectively, marking a strong recovery from FY20, when the comparable returns were +3.0% and 2.5%. Updating the numbers to end-November, TRG’s 12-month NAV and share price total returns of +18.6% and +12.8% (Exhibit 6) remain healthy, although the beginning of the strong ‘vaccine rally’ in November 2020 is now outside the 12-month period, and more recently the market has paused for breath with fears over supply chain disruption, availability of skilled labour, rising inflation and now the new omicron coronavirus variant. As such, the majority of the 12-month gains were made between December 2020 and August 2021 (Exhibit 7).

Exhibit 7: Investment trust performance to 30 November 2021

Price, NAV and index total return performance, one-year rebased

Price, NAV and index total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised.

Returns relative to European small- and large-cap indices as well as the broad UK market also show a divergence over the short and longer term, with TRG lagging all the indices shown over one, three and six months to end-November, while outperforming (with the exception of the 12-month share price total return versus the European small-cap index) over one, three, five and 10 years (Exhibit 8). This strong long-term record (albeit containing periods of volatility) has translated into annualised NAV and share price total returns of c 15–22% over three, five and 10 years (Exhibit 7, right-hand chart).

Exhibit 8: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to MSCI Eur ex-UK Small

(2.8)

(4.5)

(9.1)

(1.8)

9.6

10.0

33.8

NAV relative to MSCI Eur ex-UK Small

(1.6)

(4.2)

(7.3)

0.8

10.4

6.1

21.5

Price relative to MSCI Eur ex-UK

(3.2)

(5.7)

(9.7)

2.7

22.1

24.8

94.0

NAV relative to MSCI Eur ex-UK

(2.1)

(5.4)

(8.0)

5.5

23.0

20.4

76.1

Price relative to CBOE UK All Companies

(2.7)

(6.5)

(7.7)

1.3

48.9

62.2

179.6

NAV relative to CBOE UK All Companies

(1.6)

(6.2)

(5.9)

4.1

50.0

56.6

153.7

Source: Refinitiv, Edison Investment Research. Note: Data to end-November 2021. Geometric calculation.

In line with the more muted returns in recent months, the top 10 positive stock contributors added 5.1% to relative performance in the nine months to end-September (9M21), while the 10 largest detractors had a negative impact of -3.3% versus the benchmark. This contrasts with calendar 2020 (CY20), when the top 10 contributors added 14.4% and the biggest detractors cost -7.9%. Investors should note that owing to the highly diversified nature of the portfolio (134 holdings at 31 October 2021, with the 10 largest positions making up only 18% of the total), individual stocks are unlikely to have an outsized impact on overall returns in the short term, although over the long term they may add significant value.

Beckett points out that the winners in 9M21 have been quite different from those in CY20, when ‘stay at home’ stocks such as home furnishings website Westwing, online pharmacy Zur Rose and meal kit provider HelloFresh topped the list of positive contributors. The three biggest detractors in CY20 were Aareal Bank, ferry company DFDS (banks and travel stocks both having been out of favour in the pre-COVID-19 vaccine phase of the pandemic) and not holding vaccine beneficiary BioNTech. In 9M20, the top three contributors were Flex LNG (a beneficiary of higher gas prices), online travel agency eDreams Odigeo (as travel stocks staged a recovery) and digital display advertising firm Criteo. More recently, PVA TePla – which makes silicon/silicon carbide furnaces for semiconductor foundries – has been ‘flavour of the month’, according to Beckett, with its share price rising by c 77% between 30 June and 1 December 2021. On the negative side, energy distributor Fjordkraft will take time to pass on increased input costs, Aker BioMarine was sold after failing to live up to its promise and Basware, which makes payables software, is ‘at a massive discount to peers’, according to Beckett, and thus offers re-rating potential.

Exhibit 9: NAV performance versus MSCI Europe ex-UK Small Cap over three years

Source: Refinitiv, Edison Investment Research

Peer group comparison

Exhibit 10: European Smaller Companies peer group as at 1 December 2021*

% unless stated

Market cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Ongoing
charge

Perf.
fee

Discount
(cum-fair)

Net
gearing

Dividend
yield

TR European Growth

701.5

21.2

72.7

101.4

409.4

0.7

Yes

(12.6)

110

1.8

European Assets Trust

496.9

23.5

60.6

86.2

326.0

0.9

No

(5.4)

102

5.8

JPMorgan European Discovery

845.5

19.9

57.6

95.5

326.3

0.9

No

(14.0)

103

1.3

Montanaro European Smaller Cos

386.9

42.8

134.2

216.5

483.4

1.2

No

1.1

101

0.4

Simple average (4 funds)

607.7

26.8

81.3

124.9

386.2

0.9

(7.7)

104

2.3

TRG rank in peer group

2

3

2

2

2

4

3

1

2

Source: Morningstar, Edison Investment Research. Note: *Performance as at 30 November 2021 based on ex-par NAV. TR = total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

TRG is one of four funds in the Association of Investment Companies’ (AIC) European Smaller Companies sector. Analysis using Morningstar’s style box (split into nine squares covering large-, mid- and small-cap and value, core and growth styles) puts the trust in the small-cap core square (suggesting more of a balance between growth and value), while the peers are all more towards the mid-cap growth area. In performance terms, TRG ranks second for NAV total returns over three, five and 10 years, and third over one year.

Interestingly, the only fund to outperform it over the three longer periods, Montanaro European Smaller Companies (MTE), is the most polarised from TRG in terms of its high-growth bias (with 31% of its portfolio in technology stocks and a further 20% in biotech and healthcare at end-October), meaning it is also arguably the most vulnerable to a sustained market rotation in favour of more value and cyclical areas. TRG has roughly double MTE’s exposure to industrials (at 37.9% versus 20.0%) and financials (13.4% versus 7.0%). MTE has 32.0% of its portfolio in highly valued Sweden, whereas TRG has just 10.5%.

The second largest trust in the sector, TRG has the lowest ongoing charges, although it is the only one of the peers to carry a performance fee. In spite of its strong performance record, the trust currently trades on the second widest discount to NAV, 13.7pp wider than MTE’s 1.1% premium. Gearing at 10% is the highest in the group, well above the 4% average. TRG’s dividend yield is the highest of the three funds with a ‘natural’ yield; European Assets Trust’s high distribution policy (paying out 6% of NAV each year) means dividends are largely funded out of capital.

Dividends: Up c 14% as income bounces back

Exhibit 11: Dividend history since FY16

Source: Bloomberg, Edison Investment Research

Although it invests principally for capital growth, TRG has had a long record of rewarding its shareholders through steadily growing regular dividends, which have been paid twice yearly since FY18. For FY21, an interim dividend of 8.2p and a final dividend of 16.8p have been declared, bringing the total to 25.0p, a 13.6% increase on the FY20 dividend (which was held at the same level as FY19). Prior to FY20, dividends had been well covered by portfolio income (1.3x in FY19), but the impact of the COVID-19 pandemic on corporate profitability and cash flows caused a dramatic dip in revenues in FY20, leading to the 22.0p total dividend for the year (unchanged on FY19) being only c 0.5x covered, with the remainder funded from TRG’s reserves.

The dividend payment schedules of continental European companies mean TRG’s income receipts are massively weighted to the second half of its financial year (1 January to 30 June). This meant a large (c 63% y-o-y) drop in portfolio dividends in H220, a period that included the initial ‘panic’ phase of the pandemic, when many companies suspended payouts in light of the uncertain outlook. However, FY21 has seen a significant recovery, with net revenue returns per share almost comparable with those of FY19, at 1.36p in H121 and 19.37p in H221 (more than 2.5x the 7.61p seen in H220), compared with 1.39p in H119 and 22.69p in H219. The FY21 total dividend of 25.0p per share was thus c 0.8x covered by the 20.73p per share revenue return, a significant improvement on FY20, with the prospect (although not the guarantee) of a return to a fully covered dividend in FY22.

Based on the current share price and the last two dividends, TRG has a dividend yield of 1.8%. After accounting for the FY21 final dividend (paid after the period end), but excluding any dividend receipts in H122 to date, TRG has revenue reserves of 29.5p per share, sufficient to sustain annual dividends at the FY21 level for around 14 months. The regular dividend (excluding specials) has grown at a compound annual rate of 22.7% over the five years to end-FY21.

Discount: Still in double digits despite strong returns

At 1 December 2021, TRG’s shares traded at a 12.6% discount to cum-income NAV. While this is broadly in line with both short- and longer-term averages (11.6%, 13.0%, 10.9% and 12.7% respectively over one, three, five and 10 years), it is arguably wider than it should be given the trust’s strong recent performance. As can be seen in Exhibit 12, there was a period in late 2017 and early 2018 during which the shares traded at a small premium on the back of a 54.0% NAV total return in FY17, well below the 63.5% seen in FY21. While we acknowledge that the COVID-19 pandemic and associated difficulties such as the supply squeeze and higher inflation present a different investment landscape compared with 2017, we still believe TRG’s persistent double-digit discount is largely unwarranted given its strong long-term performance history. The board has taken steps to address this through the developments discussed on page 2.

While the board retains the authority to repurchase up to 14.99% of shares or allot shares up to the equivalent of 5% of the share capital, in order to manage a discount or a premium, in practice these powers are used sparingly, and there have been no repurchases since the summer of 2016. As shown in Exhibit 13, there was a limited amount of share issuance (c £5m) in FY18 to meet excess demand while the shares were trading at a premium.

Exhibit 12: Discount over five years

Exhibit 13: Buybacks and issuance

Source: Refinitiv, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 12: Discount over five years

Source: Refinitiv, Edison Investment Research

Exhibit 13: Buybacks and issuance

Source: Morningstar, Edison Investment Research

Fund profile: Diversified play on small-cap Europe

Launched in 1990, TRG invests for long-term capital growth in a diversified portfolio of smaller European (ex-UK) companies that its managers believe are good value. The investment team at Janus Henderson Investors – lead manager (since 2011) Ollie Beckett, assisted by deputy Rory Stokes and analyst Julia Scheufler – employs an unconstrained, bottom-up approach to portfolio construction. The fund is biased towards the smaller end of the small-cap universe, with c 66% of TRG’s assets (at 30 September 2021) invested in companies with a market capitalisation below £1bn. Smaller companies may carry a higher risk of failure and can be illiquid, so TRG’s managers prefer to mitigate stock-specific risk by holding a relatively long list of stocks (c 120–150). There is a maximum individual position size of 7%, although in practice few holdings exceed 2% of the total. While the trust is permitted to hold unquoted investments (prior board approval is required), it currently has no such positions. TRG measures its performance against the EMIX Smaller Europe ex-UK Index in sterling terms (although this will change to the MSCI Europe ex-UK Small Cap Index from 1 July 2022) and is a member of the AIC’s European Smaller Companies sector.

While TRG’s main aim is to achieve capital growth, it also has a long record of year-on-year dividend growth and since FY18 has paid an interim as well as a final dividend to spread income more evenly through the year.

Investment process: Identify mispriced growth potential

In order to achieve their aim of capturing the capital growth potential of small- to mid-cap European companies, TRG’s managers invest in securities that they believe to be mispriced relative to long-term fundamentals. The trust’s investment universe covers c 2,000 stocks across Europe with a market capitalisation below €4bn, from which Beckett, Stokes and Scheufler build a diversified portfolio of c 120–150 stocks. Using a range of quantitative screens, the team filters the opportunity set for attractive but undervalued companies. By undertaking hundreds of company meetings each year, they aim to assess the durability of business models, quality of management, drivers of growth and catalysts for revaluation. They also take account of in-house and external company research. For each potential investee company, the team builds financial models, using different valuation metrics to gain an understanding of the relationship between a firm’s growth potential and its current valuation. While they have a definite focus on mispriced securities, the managers stress that this ‘value’ approach does not mean they eschew ‘growth’ stocks. ‘We will buy growth, but only at a reasonable price’, says Beckett. The portfolio is built on a bottom-up basis, with no constraints on country or sector weighting, and position sizes are based on the managers’ degree of conviction, although they rarely exceed c 2%, given the focus on diversification.

Beckett, Stokes and Scheufler view their investment universe in terms of a company lifecycle with four stages. The managers comment that the majority of investors tend to concentrate their efforts in the middle two segments, meaning they could be missing out on attractive opportunities.

Early cycle (c 10% of the portfolio at 30 September 2021) – young companies with growing returns on capital, a clear strategy and operating leverage. The key valuation metric is enterprise value to sales (EV/sales). Current examples include menu kit supplier HelloFresh and Flex LNG, a Norwegian transporter of liquefied natural gas. Positions may be sold if operating leverage fails to materialise, growth is disappointing, the corporate narrative loses direction or management sells out of shareholdings in the business.

Quality growth (c 37%) – companies with high returns on capital, growing revenues, sustainable margins and strong competitive positions. The team uses valuation metrics including P/E multiples, EV/EBIT (earnings before interest and tax) and EV to invested capital (EV/IC). TKH – which the team says has transformed itself from a ‘boring telecom company’ to a multi-industry leader in high-tech applications such as rail safety – is an example in this category, along with Gaz Transport & Technigaz (GTT), another LNG play that supplies sophisticated membranes for lining gas transportation tanks. The sell discipline focuses on triggers such as deteriorating quality of accounting, margin compression or the company embarking on ‘incoherent’ M&A activity.

Mature (c 28%) – cash-generative companies with steady returns on capital, whose shares are trading inexpensively versus the value of their assets. Valuation metrics include EV/IC, EV/EBIT and free cash flow (FCF) yield. Examples include ferry operator DFDS, which has seen renewed passenger growth after the twin blows of Brexit and COVID-19, and Amorim, the world number one in wine corks. The team may exit positions in response to negative shifts in the competitive environment or the technological landscape, as well as if share prices re-rate to a point where the valuation no longer looks attractive.

Turnarounds (c 33%) – companies that may have suffered declining growth or a specific setback, but where management cost-cutting or asset disposals may spark an improvement in margins. Companies are valued on EV/IC, EV/EBIT and FCF yield. French cabling company Nexans is an example, with positive fundamentals given its exposure to energy transition themes such as connecting offshore wind power to the grid. Irish bank AIB also fits into this category. Positions may be sold in the event of a rapid deterioration in sales, or if margins fail to improve as expected.

Portfolio turnover averages c 40–60% a year (41.9% of average net assets in FY21, down from 56.2% in FY20 and 57.6% in FY19), implying a holding period of around 1.5 to 2.5 years, although many companies are held for much longer than this.

TRG’s approach to ESG

Beckett and the team also run Janus Henderson’s open-ended pan-European smaller companies fund, and the manager says having a client base that includes continental European (and particularly Scandinavian) institutional investors means an awareness of ESG issues has long been part of the team’s investment approach.

TRG’s approach to ESG can be summed up as follows:

ESG analysis is integrated into the investment thesis on all bottom-up stock decisions.

The team’s core belief is that companies that score well on ESG and sustainability warrant a valuation premium over time.

They seek to determine what is or is not a fair premium for those assets rather than excluding stocks on ESG ratings alone.

Society and the market dictate what is acceptable in terms of ESG practices.

The investment team analyses governance as part of its routine work, and regularly challenges management on governance issues.

The team works with Janus Henderson’s in-house Governance and Responsible Investment (GRI) team on environmental and social considerations, as well as considering ESG risk reports.

Beckett says European small-cap is at the forefront of sustainability almost by default, with many of TRG’s portfolio companies involved in areas associated with energy transition – which aligns with the United Nations’ Sustainable Development Goal (SDG) of ‘affordable and clean energy’ – as well as significant exposure to other SDGs such as good health and wellbeing, and sustainable cities and communities. However, smaller companies (by simple virtue of being more occupied in running their businesses) tend to be less focused on trumpeting their ESG credentials than larger firms with more marketing muscle, despite those ESG credentials often being more genuine and less ‘greenwashing’. Hence, Beckett describes TRG’s investment portfolio as being ‘laden with hidden ESG’, which could bear fruit in terms of a valuation premium once investors are made more aware of how these companies are helping to tackle social and environmental issues.

You can read TRG’s ESG policy (as published on the AIC website) in full here.

Gearing: Flexible borrowing in c 0–15% range

TRG is permitted to gear up to 30% of net assets, although its normal working range is 0–15%. It may also hold up to 20% in cash and/or fixed income. The trust has a £160m multicurrency overdraft facility with HSBC Bank (up from £100m in FY20), which represents available gearing of c 19% based on the current NAV. At end-FY21 (30 June 2021), £89.1m of the overdraft was drawn, a large increase from £48.3m at end-FY20, although given the c 60% rise in NAV during FY21, the percentage level of gearing remained relatively steady, at 10% versus 9% at the start of the year. At 31 October 2021, TRG’s net gearing stood at 10%, up from c 4–5% at points earlier in the summer when Beckett was ‘feeling a bit nervous’ on the outlook for markets.

Fees & charges: Lower base fee now in place

Although it already had by some distance the lowest ongoing charges (excluding performance fees) in its peer group, TRG has reduced its base management fee further with effect from 1 October 2021, to 0.55% of net assets (from 0.60%) up to £800m and 0.45% thereafter. Previously, the lower fee tier (0.50%) kicked in above £500m. Based on 1 December net assets of £802.6m, we calculate the new fee basis would result in a 0.7% increase in management fees paid. (This is a rough calculation only, given the actual fees are calculated and paid quarterly.) The benefits of the reduction will accrue more if TRG’s net assets rise further above the £800m mark (note the net assets figure was c £830m in mid-November, which would have resulted in a 2.5% reduction in management fees versus FY21). The base ongoing charge at end-FY21 was 0.71% (FY20: 0.72%). We see good potential for this to fall below 0.70% under the new management fee structure.

Janus Henderson Investors may also be paid a performance fee (15% of excess performance, subject to a cap on total fees at 2.0% of net assets at the end of the period) if TRG’s NAV total return outperforms the benchmark EMIX Smaller Europe exUK Index by more than 1.0% on a rolling three-year basis. In FY21, a performance fee of just over £4.5m was paid; including this and based on average net assets, we calculate annualised ongoing charges including the performance fee to be 1.35%. No performance fee was paid in respect of FY20 or FY19. With effect from the beginning of FY23 (1 July 2022), the new benchmark index (MSCI Europe ex-UK Small Cap) will be adopted, and the performance fee calculation (which in other respects will be unchanged) will be based on outperformance of this index from this date.

Capital structure: Share split aims to boost liquidity

Exhibit 14: Major shareholders (as at 1 Nov 2021)

Exhibit 15: Average daily volume

Source: Bloomberg. Note: *Formerly Wells Capital Management.

Source: Refinitiv. Note 12 months to 1 December 2021.

Exhibit 14: Major shareholders (as at 1 Nov 2021)

Source: Bloomberg. Note: *Formerly Wells Capital Management.

Exhibit 15: Average daily volume

Source: Refinitiv. Note 12 months to 1 December 2021.

TRG is a conventional investment trust with one class of share. At 1 December 2021, there were 50.1m ordinary shares in issue, a level unchanged since November 2017. Following approval of the proposed eight-for-one share split at the FY21 AGM on 29 November, this will rise to 400.9m with effect from 13 December 2021. As shown in Exhibit 14, TRG has a significant level of retail investor ownership, with three of the top four shareholders (accounting for 26.5% of the share base) being direct-to-consumer platforms. However, the largest shareholder, with 14.0% of shares outstanding, is currently Allspring Global Investments, the newly renamed Wells Capital Management, whose shareholding has increased from c 5.5% of the total at the start of 2021. Together with City of London IM and Lazard, this amounts to a significant 24.1% representation from more discount-focused institutions. The balance of the top shareholders (those holding at least 2.5% of TRG’s equity) is made up of traditional wealth managers Investec, Tilney Smith & Williamson and Rathbones. There is a reasonable level of trading liquidity in the shares (Exhibit 15), with an average of 63,100 shares changing hands every day over the 12 months to 1 December 2021; however, the board hopes the share split will increase liquidity as well as facilitating regular retail investment via platforms.

The board

Exhibit 16: TR European Growth Trust’s board of directors

Board member

Date of appointment

Remuneration in FY21

Shareholdings at end-FY21

Christopher Casey (chair)

2010 (2019)

£38,000

6,000

Dan Burgess (audit committee chair)

2019 (2019)

£34,000

2,000

Simona Heidempergher (SID)

2014 (2021)

£30,000

1,600

Alexander Mettenheimer

2011

£30,000

2,000

Ann Grevelius

2019

£30,000

0

Source: TR European Growth Trust

Having delayed his planned departure by a year in order to help steer the trust through the COVID-19 pandemic, Andrew Martin Smith retired from the board at the FY21 AGM on 29 November 2021. Alexander Mettenheimer has indicated his intention to step down at the FY22 AGM.

The directors’ fees, which are subject to an aggregate maximum of £250,000 and were last increased in FY19, will rise in FY22 to £44,000 for the chairman (+15.8%), £35,190 for the audit committee chairman (+3.5%) and £31,050 for the other directors (+3.5%), including the senior independent director (SID).

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This report has been commissioned by TR European Growth Trust and prepared and issued by Edison, in consideration of a fee payable by TR European Growth Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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1185 Avenue of the Americas

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General disclaimer and copyright

This report has been commissioned by TR European Growth Trust and prepared and issued by Edison, in consideration of a fee payable by TR European Growth Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

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This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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