Henderson EuroTrust — Performance is getting back on track

Henderson EuroTrust (LSE: HNE)

Last close As at 20/06/2024

GBP1.58

0.50 (0.32%)

Market capitalisation

GBP335m

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Research: Investment Companies

Henderson EuroTrust — Performance is getting back on track

Henderson EuroTrust’s (HNE’s) performance is getting back on track as investors have become more focused on company fundamentals rather than macroeconomic factors, and investors’ strong preference for value stocks (translating into style headwinds for HNE between Q121 and Q222) has waned recently. The manager (Jamie Ross) is building on HNE’s NAV 10 year record of outperformance versus the Europe ex-UK market (10.5% pa versus 9.1% pa respectively), based on a concentrated portfolio of high-quality growth stocks. European equities are very attractively valued and, coupled with the trust’s double-digit discount, this should make HNE worthy of consideration.

Melanie Jenner

Written by

Mel Jenner

Director, Investment Trusts

henderson

Investment Companies

Henderson EuroTrust

Performance is getting back on track

Investment trusts
European ex-UK equities

25 July 2023

Price

139.0p

Market cap

£295m

Total assets

£345m

NAV*

160.0p

Discount to NAV

13.1%

*Including income at 20 July 2023.

Yield

2.7%

Shares in issue

211.9m

Code/ISIN

HNE/GB00BP6QR382

Primary exchange

LSE

AIC sector

Europe

Financial year-end

31 July

52-week high/low

140.5p

106.0p

NAV* high/low

164.5p

129.4p

*Including income

Net gearing*

0%

*At 30 June 2023

Fund objective

Henderson EuroTrust aims to achieve a superior total return from a portfolio of European (excluding the UK) investments where the quality of the business is deemed to be high or significantly improving. HNE has an all-cap mandate but tends to have a bias towards large and medium-sized companies. ESG factors are embedded within the investment process.

Bull points

Long-term record of outperformance.

Experienced manager and well-resourced collegiate team.

Competitive fee structure.

Bear points

HNE’s relative performance is likely to struggle in a market led by value stocks.

The European macroeconomic backdrop remains uncertain.

Moderate fund size may deter some investors.

Analyst

Mel Jenner

+44 (0)20 3077 5700

Henderson EuroTrust is a research client of Edison Investment Research Limited

Henderson EuroTrust’s (HNE’s) performance is getting back on track as investors have become more focused on company fundamentals rather than macroeconomic factors, and investors’ strong preference for value stocks (translating into style headwinds for HNE between Q121 and Q222) has waned recently. The manager (Jamie Ross) is building on HNE’s NAV 10year record of outperformance versus the Europe ex-UK market (10.5% pa versus 9.1% pa respectively), based on a concentrated portfolio of high-quality growth stocks. European equities are very attractively valued and, coupled with the trust’s double-digit discount, this should make HNE worthy of consideration.

NAV vs Europe ex-UK index (12 months to end-June 2023); performance getting back on track following a difficult period of stock market rotation

Source: Refinitiv, Edison Investment Research

Why consider HNE?

HNE offers investors a high-conviction portfolio of around 45 European quality businesses. As the trust is a closed-end fund, Ross does not face redemption pressures and is overseen by an independent board of directors. The manager’s investment approach is well defined and repeatable, and ESG/sustainability analysis is an integral part of the process (HNE is designated as a Light Green fund under Article 8 of the EU Sustainable Finance Disclosure Regulation). Ross seeks companies with consistently high returns (‘compounders’ – c two-thirds of the fund) and those with underappreciated improving returns (‘improvers’ – c one-third).

European equity valuations are very attractive in both absolute and relative terms (Exhibit 1) and while Europe ex-UK has been one of the best performing regions so far this year, in recent years it has been out of favour. Hence, now could be an interesting time to consider a high-quality fund with a proven long-term track record.

Ross reports that, based on historical data, having inflation back in the system should favour the relative performance of European equities, while a more benign interest rate backdrop this year is likely to be beneficial for the relative performance of HNE’s portfolio of high-quality growth stocks.

There is scope for the trust to be afforded a higher valuation now its performance is improving, or if investors become less risk-averse. HNE has one of the widest discounts in its sector despite its performance being above average over the last one, five and 10 years.

HNE: Well positioned for growth stock outperformance

From a broad perspective, Europe should now be viewed in a brighter light

Over the last 15 years, there has been a perception change by international investors about European equities. During the global financial crisis, and in subsequent years, there was low regard for Europe, including criticism about the European Central Bank (ECB) being slow to cut interest rates after the global financial crisis and too quick to raise them thereafter. The ECB started quantitative easing in 2015, which was seven years later than the US Federal Reserve. However, in recent years Europe has been more responsive in terms of its monetary policy actions and the way it dealt with the COVID-19 crisis. Also, over the last 15 years the European banking regulatory framework has been made more robust and transparent, meaning there is less likelihood of Europe following the US with regards to recent regional bank failures.

The investment backdrop

Although the macroeconomic backdrop is uncertain due to a range of factors including rising interest rates (as central banks attempt to bring higher inflation under control), consumers struggling with escalating living costs and heightened geopolitical tensions, global investors may benefit from an allocation to European equities. The region has a comparable growth outlook to other advanced economies in 2024 and there is potential for a re-rating considering the wide discount between the valuations of European and global equities.

Exhibit 1: Performance of indices and valuations

Performance of indices (last 10 years, £ adjusted)

Valuation metrics of Datastream indices (at 21 July 2023)

 

Last

High

Low

10-year
average

Last as % of
average

Europe ex UK

P/E 12 months forward (x)

13.1

18.5

11.3

14.7

89

Price to book (x)

1.9

2.1

1.3

1.7

109

Dividend yield (%)

3.1

4.4

2.1

3.0

104

Return on equity (%)

12.3

13.7

5.3

9.6

128

World

P/E 12 months forward (x)

15.6

19.9

12.5

15.5

100

Price to book (x)

2.4

2.5

1.5

2.0

120

Dividend yield (%)

2.3

3.4

1.8

2.4

96

Return on equity (%)

12.8

14.0

7.4

11.1

115

Source: Refinitiv, Edison Investment Research

Exhibit 2: HNE NAV performance versus MSCI Europe ex-UK Index over 10 years

Source: Refinitiv, Edison Investment Research

As shown above in Exhibit 2, HNE’s performance is improving following a tough time between Q121 and Q222. This period was characterised by a change in investor preference from growth to value stocks as economies reopened following lockdowns. The market shift was exacerbated by rising interest rates as central banks sought to combat higher inflation following COVID-19-induced supply bottlenecks and the Russian invasion of Ukraine. Higher interest rates generally lead to a devaluation of growth stocks due to the negative effect of a larger discount rate on the value of their long-term cash flows.

Ross reports that, in terms of the operating environment, Q123 corporate results exceeded consensus expectations on both the top and bottom line and there was strong order intake from industrial companies. Recent data suggest that the chances of a European recession have reduced despite a softening in business conditions in some sectors of the economy.

So far this year, there have been periods of both growth and value stock market leadership in Europe. Growth stocks had enjoyed a multi-year period of outperformance until November 2021 fuelled by low interest rates and a derating of lower-quality names. However, the release of positive trial data for Pfizer/BioNTech’s COVID-19 vaccine saw value stocks start to outperform, in anticipation of lockdowns ending and a pickup in economic growth.

Growth stocks derated in 2022 in a rising interest rate environment due to high inflation caused by supply chain bottlenecks during the pandemic and increased demand thereafter. With inflation moderating, there is potential for growth stocks to again lead the market. The manager highlights that looking at data to mid-May 2023, over the prior three years the MSCI Europe Value Index outperformed the MSCI Europe Growth Index by 20pp, but in the two years prior the outperformance was just 5pp, suggesting the preference for value stocks is waning.

Exhibit 3: Performance of MSCI Europe growth versus value indices over five years

Source: Refinitiv, Edison Investment Research

Current portfolio breakdown

Sector positioning

Ross explains that over the long term, the fund has been biased towards the consumer, healthcare and technology sectors as these tend to contain high-quality, high-return businesses with decent growth. These qualities are less evident in the material, energy, real estate and utility sectors, where returns are generally lower.

The release of the positive Pfizer/BioNTech COVID-19 vaccine data led the manager to increase HNE’s financials exposure in anticipation of economic recovery; the trust has an overweight exposure, which is unusual. Following the pandemic, Ross found some additional attractive financials investments but is now inclined to reduce HNE’s exposure. As an example, he has taken profits in UniCredit, whose share price has appreciated from around 6 in May 2020 to around 21 now. The bank has benefited from inflation and higher interest rates, and is overcapitalised so has been able to distribute cash to shareholders for the first time in many years.

Combining the two consumer sectors, the trust’s exposure is currently broadly in line with the benchmark. HNE has a healthy exposure to high-quality luxury goods via its holdings in LVMH, Hermes International and Moncler. These companies have strong pricing power, sell desirable products for which there is strong demand and their business has been buoyed by China reopening its economy; China can make up a third of luxury goods companies’ total revenues.

Within technology, the manager favours semiconductor equipment companies as they are less cyclical than semiconductor manufacturers. He already had a position in ASML, but, during a period of sector weakness in 2022 when ‘the baby was thrown out with the bathwater’, Ross took the opportunity to add ASM International and BE Semiconductor Industries to the fund. He says that these are the three highest gross margin and return generators in the European semiconductor industry (there are six listed semiconductor companies with market caps greater than €5bn).

The manager is increasingly finding attractive healthcare stocks, such as large-cap pharma companies. HNE already has holdings in Novo Nordisk, Roche and Sanofi. In general, the valuations of large-cap pharma companies have derated as their innovation cycles have not produced breakthrough drugs; drug discovery has been more prevalent at smaller biotech companies. Ross comments that biotech stocks thrived in a low interest rate and easy access to capital environment. Now with higher interest rates, the funding environment is tougher so maybe the large companies that are well capitalised should do better. Roche is trading on a 13x forward P/E multiple versus 15x to 16x historically. Sanofi is trading on an 11x forward P/E multiple and has revenue growth of 3% to 5% per year, plus some operating leverage. With no debt, and free cash flow generation in the high single-digits range, the manager considers Sanofi to be an attractive proposition and he suggests that, with a modest change in investor perception, both Roche and Sanofi could re-rate to high-teens forward P/E multiples. These two pharma companies are examples of ‘compounders’.

Ross says that Novo Nordisk (a ‘compounder’) has transcended the pharma sector, consistently generating good numbers and is trading on a 30x forward P/E multiple. In 2015, there were concerns about pricing pressure in insulin and the stock was trading below 15x, so essentially the company’s valuation has now doubled. The manager explains that Novo has features favoured by his team. Novo invested in insulin products 100 years ago and by 2015 diabetes treatment was essentially all the firm undertook. The company has a long-term research and development focus, but, in 2015, it took advantage of the beneficial side effects of its semaglutide diabetes medicine, namely its ability to reduce bodyweight and positively affect cardiovascular outcomes. This product is now specifically used in obesity treatment and demand for the product is so great that it is now outstripping supply.

Exhibit 4: Portfolio sector exposure versus benchmark (% unless stated)

Portfolio end-
Jun 2023

Portfolio end-
Dec 2022

Change
(pp)

Index
weight

Active weight
vs index (pp)

Trust weight/
index weight (x)

Healthcare

18.6

16.4

2.2

15.9

2.7

1.2

Financials

18.1

20.3

(2.2)

16.4

1.7

1.1

Industrials

13.7

12.9

0.8

17.9

(4.2)

0.8

Consumer staples

11.6

11.6

0.0

9.0

2.6

1.3

Consumer discretionary

11.3

9.6

1.7

14.3

(3.0)

0.8

Technology

10.6

9.3

1.3

9.5

1.1

1.1

Materials

5.6

7.0

(1.4)

4.5

1.1

1.2

Energy

4.9

6.0

(1.1)

4.0

0.9

1.2

Communication services

4.0

5.1

(1.1)

3.1

0.9

1.3

Utilities

1.5

1.8

(0.3)

4.3

(2.8)

0.3

Real estate

0.0

0.0

0.0

0.9

(0.9)

0.0

Total

100.0

100.0

Source: HNE, Edison Investment Research. Note: Numbers subject to rounding.

The largest sector changes in the six months to end-June 2023 were an increased exposure to healthcare (+2.2pp) and a lower financials weighting (-2.2pp). Compared with the benchmark, the trust’s largest overweight positions were healthcare (+2.7pp) and consumer staples (+2.6pp), with underweight positions in industrials (-4.2pp), consumer discretionary (-3.0pp) and utilities (-2.8pp).

Recent additions and disposals in the fund

HNE has a new position in BNP Paribas (an ‘improver’), which was funded by reducing the positions in UniCredit and Bawag. BNP is an early beneficiary of rising interest rates, although the most powerful period of a net interest margin boost is likely coming to an end. It is less interest rate dependent than the trust’s other bank holdings and has a lower beta, so essentially the manager is derisking the fund’s bank exposure.

Another new position in the fund is ophthalmology company Alcon (an ‘improver’), which was previously a low-priority business within Novartis. Alcon was spun out in 2019, having suffered from a lack of investment, so margin progression as a standalone company has been slow because of the need to invest capital. However, the benefits of the capex programme are starting to come through and Alcon posted very strong Q123 results.

Industrie de Nora (a ‘compounder’) has been added to HNE’s portfolio; it specialises in electrochemistry, is a leader in sustainable technologies and has an important role in the green economy. The company is the world’s largest supplier of high-performing catalytic coatings and insoluble electrodes for electrochemical and industrial applications and is a leading provider of solutions for water and wastewater treatment. According to the manager, Industrie de Nora generates decent margins and returns and is involved in the production of green hydrogen. It has a high market share in this new end market that is exhibiting very strong growth.

There have been no complete disposals in the fund in recent months.

Geographic positioning

While HNE’s sector and geographic exposures are all a product of its bottom-up stock selection, it is interesting to consider the fund’s composition. In the six months to end-June 2023, the largest geographic changes were a higher weighting to Switzerland (+2.4pp) and a lower exposure to Austria (-2.9pp). Compared with the benchmark HNE had a notable 9.2pp higher weighting to France, with zero exposure to ‘other’ European countries, which made up 12.1pp of the index.

Exhibit 5: Portfolio geographic exposure versus benchmark (% unless stated)

Portfolio end-
Jun 2023

Portfolio end-
Dec 2022

Change
(pp)

Index
weight

Active weight vs index (pp)

Trust weight/
index weight (x)

France

32.6

30.6

2.0

23.4

9.2

1.4

Switzerland

19.4

17.0

2.4

19.3

0.1

1.0

Germany

15.5

16.1

(0.6)

16.7

(1.2)

0.9

Netherlands

11.9

13.6

(1.7)

9.2

2.7

1.3

Denmark

6.2

5.7

0.5

5.7

0.5

1.1

Italy

6.1

5.9

0.2

5.3

0.8

1.1

Spain

3.8

3.5

0.3

5.2

(1.4)

0.7

Finland

1.9

1.8

0.1

2.3

(0.4)

0.8

Portugal

1.5

1.8

(0.3)

0.4

1.1

3.7

Austria

1.1

4.0

(2.9)

0.4

0.7

2.6

Other

0.0

0.0

0.0

12.1

(12.1)

0.0

Total

100.0

100.0

100.0

Source: HNE, Edison Investment Research. Note: Numbers subject to rounding.

Top 10 holdings

At the end of June 2023, HNE’s top 10 positions made up 42.5% of the fund, which was a lower concentration compared with 45.0% six months earlier; seven positions were common to both periods.

Exhibit 6: Top 10 holdings (at 30 June 2023)

Company

Country

Sector

Portfolio weight %

30 Jun 2023

31 Dec 2022*

Novo Nordisk

Denmark

Pharmaceuticals & biotech

6.2

5.8

TotalEnergies

France

Oil, gas & coal

4.9

6.0

Nestlé

Switzerland

Food producer

4.9

5.3

Sanofi

France

Pharmaceuticals & biotech

4.4

4.4

Roche

Switzerland

Pharmaceuticals & biotech

4.4

4.9

ASML

Netherlands

Technology hardware & equipment

4.0

3.3

LVMH Moët Hennessy Louis Vuitton

France

Personal goods

3.7

N/A

Hermes International

France

Luxury goods

3.7

N/A

UniCredit

Italy

Banks

3.3

4.2

SAP

Germany

Software & computer services

3.0

N/A

Top 10 (% of portfolio)

42.5

45.0

Source: HNE, Edison Investment Research. Note: *N/A where not in end-December 2022 top 10.

Performance: Resuming positive trend

HNE is the smallest of seven funds in the AIC Europe sector. Within the peer group there is a range of styles between high growth and value; the trust has a blended bias of growth and quality and is not at the high growth end of the spectrum. HNE’s NAV total returns are above average over the last one, five and 10 years, ranking fourth over all these periods. Over the last three years, the market has favoured funds with more of a value rather than a growth bias and the trust ranks sixth. HNE has one of the widest discounts in a group where no funds are trading at a premium. It is currently ungeared and has an above-average dividend yield, which is c. 70bp above the mean. However, it should be noted that JPMorgan European Growth & Income, the fund with the highest yield, pays dividends based on its quarterly NAV, rather than income.

Exhibit 7: AIC Europe peer group at 21 July 2023*

% unless stated

Market cap (£m)

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Discount (cum-fair)

Ongoing charge

Perf.
fee

Net gearing

Dividend yield

Henderson EuroTrust

294.5

19.1

14.5

46.1

161.5

(13.4)

0.8

No

100

2.7

Baillie Gifford European Growth

346.7

6.2

(9.7)

9.5

73.3

(14.1)

0.6

No

110

0.7

BlackRock Greater Europe

549.4

18.7

29.2

66.5

190.6

(5.9)

1.0

No

106

1.2

European Opportunities Trust

789.8

7.4

16.0

13.0

136.1

(11.5)

1.0

No

108

0.3

Fidelity European Trust

1,455.1

19.3

34.5

60.0

180.4

(4.9)

0.8

No

113

2.2

Henderson European Focus Trust

345.7

20.3

33.9

48.4

169.5

(10.4)

0.8

No

101

2.7

JPMorgan European Growth & Inc

405.8

20.3

38.0

40.2

143.5

(11.7)

0.7

No

104

4.5

Simple average

598.1

15.9

22.3

40.5

150.7

(10.2)

0.8

106

2.0

HNE rank in sector (7 funds)

7

4

6

4

4

6

3

7

2

Source: Morningstar, Edison Investment Research. Note: *Performance to 21 July 2023 based on ex-par NAV. TR, total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

Exhibit 8: HNE performance to 30 June 2022

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.

Exhibit 9: Five-year discrete performance data

12 months ending

Share price
(%)

NAV
(%)

MSCI Europe ex-UK
(%)

MSCI World
(%)

CBOE UK All Cos
(%)

30/06/19

7.6

8.0

8.2

10.9

0.3

30/06/20

10.4

13.8

0.6

6.5

(13.6)

30/06/21

24.2

20.3

22.6

24.9

21.1

30/06/22

(23.3)

(18.5)

(9.8)

(2.1)

2.2

30/06/23

24.0

21.9

20.0

13.8

8.3

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

HNE’s relative returns are shown in Exhibit 10. Its NAV has outperformed the European (ex-UK) market over the last one, five and 10 years, while lagging over the last three years. Although it has outperformed the world market over the last 12 months, the trust has fared less well over the longer time periods shown. This is due to the performance of the US market, which dominates global indices and has performed relatively well in most years over the last decade (in US$ terms, the S&P 500 Index has outpaced the performance of the MSCI World Index in nine out of 10 years). HNE has performed considerably better compared with the broad UK market over the last one, five and 10 years.

Exhibit 10: HNE share price and NAV total return performance, relative to regional and global indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to MSCI Europe ex-UK

(1.3)

0.0

(0.4)

3.3

(11.0)

(2.9)

6.5

NAV relative to MSCI Europe ex-UK

(0.5)

0.3

0.6

1.5

(10.0)

1.6

13.4

Price relative to MSCI World

(2.2)

(3.3)

0.0

9.0

(15.1)

(14.7)

(18.1)

NAV relative to MSCI World

(1.4)

(3.1)

1.0

7.1

(14.2)

(10.7)

(12.7)

Price relative to CBOE UK All Companies

0.0

1.3

6.6

14.5

(11.8)

20.9

42.9

NAV relative to CBOE UK All Companies

0.8

1.5

7.7

12.5

(10.8)

26.5

52.2

Source: Refinitiv, Edison Investment Research. Note: Data to end-June 2023. Geometric calculation.

Ross has continued to adhere to his disciplined investment process, seeking reasonably priced, quality companies with high or improving returns on capital. He is confident that this strategy will lead to the restoration of HNE’s record of outperformance over the medium term. The manager highlights that stock selection rather than sector allocation drives the trust’s performance.

Commenting on HNE’s performance so far this year, positive contributors include financial stocks such as Bawag and UniCredit, luxury goods manufacturers, especially Hermes, Kion, which manufactures materials handling equipment and the trust’s semiconductor equipment names. Stocks that have detracted from performance include Sanofi, TotalEnergies and Universal Music Group, where the manager is positive on the company’s long-term fundamentals, but recent attention on the rise of artificial intelligence has raised questions about the ability of music artists to monetise the value of their assets; the position has recently been reduced. Euronext has been another performance detractor. The business has good revenue visibility and high returns, and the company made a surprise offer for Allfunds, which operates outside Euronext’s core business; the bid was subsequently withdrawn.

Dividends: Running down revenue reserves

Consistent with HNE’s focus on capital growth, in FY21, the board announced a change in the company’s dividend policy, whereby distributions would be broadly based on the level of income received. At the time, the trust had significant revenue reserves, the majority of which would be paid out over the following three to four years in additional to a ‘normal’ dividend paid from income. In FY21, income was lower than expected due to COVID-19 effects on company dividends. The total distribution for the financial year was £5.3m (£3.5m income plus £1.8m from revenue reserves). In FY22 the annual dividend increased by 52% year-on-year without the use of any revenue reserves, which should be paid out in the next two financial years. Income in FY22 was particularly strong, partly due to banks Bawag and UniCredit resuming dividend payments following the lifting of COVID-19 related restrictions, but also from many portfolio companies increasing their dividends.

So far in FY23, a 0.80p per share dividend has been announced, which is in line with the prior four financial years. Based on its current share price, HNE offers a 2.7% dividend yield.

Exhibit 11: Dividend history since FY17

Source: Bloomberg, Edison Investment Research. Note: Adjusted for 10:1 share split on 22 November 2021.

Valuation: Scope for a narrower discount

Exhibit 12: Discount over the last three years (%)

Source: Refinitiv, Edison Investment Research

In keeping with the broader investment trust sector, HNE’s discount has widened since the beginning of 2022 during a period of higher interest rates and heightened investor risk aversion. The trust’s latest 13.1% share price discount to cum-income NAV compares with an 11.4% to 18.7% range of discounts over the last 12 months and is wider than HNE’s three-, five- and 10-year averages. There is scope for the trust to be afforded a higher valuation if its relative performance improves, or if the macroeconomic backdrop becomes less uncertain and investors are willing to take on more risk.

At the November 2021 AGM, shareholders approved the board’s proposals for a 10:1 share split to make them more appealing to retail investors and to increase liquidity. Renewed annually, HNE’s board has the authority to repurchase 14.99% of the share base and allot shares from treasury. However, no shares have been bought back or issued since FY16.

Fund profile: High quality and relatively concentrated

HNE was launched in July 1992 and is listed on the Main Market of the London Stock Exchange. Jamie Ross became the trust’s sole manager in February 2019, having previously been appointed as joint fund manager in October 2018 and deputy fund manager in March 2017. He joined Janus Henderson Investments (JHI) in 2007 as part of its graduate programme and has worked in its European equities team since 2009.

Ross aims to generate a superior total return from a portfolio of European (ex-UK) companies with a high, or significantly improving, return on invested capital. The fund is relatively concentrated, holding between 35 and 55 stocks, and the all-cap mandate has a bias to large and medium-sized companies. At the time of investment, a maximum 10% of the portfolio may be in a single company. There are no restrictions on HNE’s geographic or sector exposure and there is no defined yield target. Unlisted companies are permitted, up to 10% of the portfolio (none are currently held). Cash and equivalents up to 20% and gearing up to 30% of total assets are permitted. The trust’s performance is measured against a broad Europe (ex-UK) index.

Investment process: Focus on high/improving returns

Ross believes that the most effective way to make money for HNE’s shareholders over the long term is to invest in companies that are generating a high return on invested capital or those that are expected to see a significant improvement in returns. He seeks high-quality companies with strong growth potential that are undervalued versus their growth prospects or are undergoing a significant change in management or corporate structure, for example. ESG considerations are an integral part of the investment process.

The manager defines high-return businesses as ‘compounders’ and those with an improving return profile as ‘improvers’. The portfolio exposure is broadly split two-thirds and one-third between compounders and improvers respectively. Focusing on return on capital and having a long-term perspective allows Ross to determine whether a company has sustainable business practices.

For every potential investment, the manager builds a financial model and compiles an investment thesis to explain why a company appears attractive. The investment approach is the same, irrespective of a company’s sector, and is based on a ranking framework that has three elements. Quality and valuation illustrate a business’s fundamental attractiveness, while momentum provides information about the potential timelines of an investment. A score is allocated for the quality, valuation and momentum attributes to achieve a single ranking framework score for each company analysed. The score frames the debate about the ‘competition for capital’ within HNE’s portfolio. A score for sustainability considerations accounts for half of the whole quality score, so it has a meaningful impact on a company’s ranking framework score.

Ross is a member of JHI’s European equities team, which conducts more than 450 company meetings a year covering a wide range of topics including ESG and sustainability. Meeting notes are circulated and debated both within the European equities team and with the wider JHI investment teams. HNE’s portfolio has an active share of c 70%; this is a measure of how a fund differs from its benchmark, with 0% meaning full index replication and 100% representing zero commonality.

HNE’s approach to ESG

HNE’s board holds the manager to account regarding the sustainability of businesses within the portfolio. To further tighten the focus on sustainability, from 1 January 2022, the manager is required to provide a description of the extent to which environmental or social characteristics have been met with regards to being a Light Green fund under Article 8 of the EU Sustainable Finance Disclosure Regulation.

The trust does not invest in companies that derive more than 5% of their revenues from any of the following businesses: the production of shale energy, palm oil, arctic oil and gas; the production or selling of tobacco; or from involvement in the adult entertainment sector. A maximum 5% of the trust’s portfolio may be invested in companies, which are classed as ESG laggards. The ESG risk rating measures the degree to which a company’s economic value is at risk due to ESG factors, as assessed through MSCI’s calculation of the firm’s unmanaged ESG risks. The bottom 5% of the benchmark index constituents are excluded when ranked by carbon intensity, where the data used to rank the businesses is reasonably sufficient and accurate. At least 5% of the portfolio is invested in companies that are aligned with the United Nations (UN) sustainable development goal of ‘good health & wellbeing’. The manager only invests in companies that comply with the UN global compact principles, which is a voluntary framework encouraging businesses worldwide to adopt sustainable and socially responsible policies.

HNE considers that a company is sustainable if its management thinks, acts and allocates capital to maximise long-term growth in its net worth in a way that benefits its wider stakeholders. A sustainable company requires its management to consider the long-term implications of how the firm affects the environment, societies and its other stakeholders.

Gearing

HNE has a £25m unsecured loan facility. The board has delegated responsibility for day-to-day gearing levels to the fund manager, with a normal level expected to be between 2% and 6% of NAV. Ross does not use gearing to time anticipated market moves. Gearing increases when he finds attractive, stock-specific opportunities in which to invest and declines when he is a net seller for stock-specific reasons.

Fees and charges

HNE’s annual management fee is 0.65% of NAV up to £300m of net assets and 0.55% of NAV above £300m of net assets, payable quarterly in arrears. No performance fee is payable. Reflecting the board’s anticipated future total returns, HNE’s fees are allocated 80% to the capital account and 20% to the revenue account. In FY22, the trust’s ongoing charges were 0.75%, which was 3bp lower than 0.78% in FY21.

Capital structure

Exhibit 13: Major shareholders and platforms

Exhibit 14: Average daily volume

Source: Bloomberg. Note: At 31 May 2023.

Source: Refinitiv. Note: 12 months to 21 July 2023.

Exhibit 13: Major shareholders and platforms

Source: Bloomberg. Note: At 31 May 2023.

Exhibit 14: Average daily volume

Source: Refinitiv. Note: 12 months to 21 July 2023.

HNE is a conventional investment trust with one class of share; there are currently 211.9m ordinary shares outstanding. Its average daily trading volume over the last 12 months was c 210k shares.

The three largest shareholders (Allspring Global Investments, 1607 Capital Partners and City of London), which equate to around a third of HNE’s share base, specialise in investing in closed-end funds, which they consider to be trading at anomalous discounts to their net asset values.

The board

Exhibit 15: HNE’s board of directors in FY22

Board member

Date of appointment

Remuneration in FY22

Shareholdings at end-FY22

Nicola Ralston (chairman since 26 March 2014)

1 September 2013

£38,000

120,000

Rutger Koopmans

18 May 2016

£32,735

49,000

Katya Thomson

17 May 2017

£32,000

45,000

Stephen King

1 December 2019

£27,000

15,000

Source: HNE

Nicola Ralston has announced her intention to step down at the November 2023 AGM.

On 20 September 2022, the board announced the appointment of Stephen White as a non-executive director with effect from 1 December 2022. At that time he also joined the audit and risk, insider, management engagement and nominations committees. White is a former investment manager with more than 35 years’ experience, notably 20 years as head of European equities at F&C Asset Management, where he was also manager of F&C Eurotrust and deputy manager of the F&C Investment Trust. Previously, White spent 10 years as head of European and US equities at British Steel Pension Fund. He is currently chairman of Brown Advisory US Smaller Companies, a director of Polar Capital Technology Trust and audit committee chairman of BlackRock Frontiers Investment Trust and Aberdeen New India Investment Trust.

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This report has been commissioned by Henderson EuroTrust and prepared and issued by Edison, in consideration of a fee payable by Henderson EuroTrust. 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 2023 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.

United Kingdom

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.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

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.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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