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Henderson European Focus laments fickle markets

In the financial year to 30 September 2016, Henderson European Focus Trust produced total return NAV per ordinary share of 20.4%. This compares to a total return of 21.1% for the Europe ex UK Index in sterling terms.  The share price total return was 8.6%.

The shares continued to trade in a tight range relative to NAV per ordinary share, and for part of the year traded at a premium. full year dividend to 26.40, an increase of 7.1% over last year’s distribution.

We thought it was worth while reproducing John Bennett’s manager’s report in full:

As indicated in our interim report, this year has served up headwinds as well as tailwinds. Indeed, we have found ourselves, as an investment team, lamenting the fickle rotation which has characterised European markets throughout the year. While this can often be ascribed to the usual “macro” noise – from putative China meltdown to European banking crisis to Brexit – our read is that there is an underlying lack of conviction among investors. As far as market direction is concerned it has to be said that we share this sense of unease. Our own queasiness has less to do with macro or geopolitical dramas and more to do with the fact that bargains remain hard to come by. It was this key point that led us to enter 2016 cautioning that delegating the task of making money to an equity index was unlikely to prove rewarding. This doesn’t seem to have been wide of the mark as indices have struggled since the turn of the year.

The principal headwind for our portfolio in the last year has been the pharmaceutical sector. Since our decision to favour this industry in the spring of 2010 it has yielded ample reward. Yet, the past year has seen it stall. Much of this can be attributed to the electioneering of the US Presidential candidates, with Hillary Clinton particularly voluble on the sector. To dismiss the debate on drug pricing as wholly irrelevant would be a mistake.  Our analysis tells us that the direction of travel is indeed to a tougher pricing environment but – and it is an important but – those companies discovering and launching drugs which meet unmet clinical needs will secure their patents, their pricing and their future. It is the me-too brigade who should be afraid. Our health care overweight is now focused around the two Swiss names Novartis and Roche as well as Germany’s Fresenius.

Within health care, by far the biggest disappointment has been Bayer. Having seen Syngenta being bid for by ChemChina, it appears that the Company has been bounced into a blockbuster acquisition of its own, in the shape of Monsanto. We engaged actively with Bayer’s management in an effort to persuade them to call off the wedding but, alas, to no avail. As often happens, M&A in any given industry can unleash the “fear of missing out” (“FOMO”) and a headlong rush toward gigantism. Long suffering investors in Europe’s hapless banking sector would no doubt attest.

Bayer’s management team isn’t the first and won’t be the last to succumb to FOMO.  We may, of course, be proven wrong but our number crunching suggests to us that this deal is unlikely to prove value accretive to Bayer shareholders anytime soon. Thus, we voted with our feet and sold our holding.

If we turn our attention to the tailwinds of the past year we should repeat the Chairman’s point regarding currency. Sterling’s accelerated devaluation post Brexit has provided a useful boon to the NAV, for which we should be grateful in an otherwise tough year for European indices. Yet, it would be wrong to believe that only the currency has provided succour. Upon assuming management responsibility for the portfolio in December 2010, I was keen to increase the Company’s exposure to small and mid-cap companies. Europe is much maligned for its “macro”, its politics and its “leaders” with their unmatched ability to take an eternity to decide on seismic issues such as whether we should have still or sparkling water. Yet, when we do stick to our knitting, we are reminded of this Continent’s opportunity. This is no better highlighted than by its wealth of small and mid-cap stocks.  As we often remind investors, we don’t care where our companies were born: we care about what they go on to do.

Investors will note that those companies capitalised at up to EUR5 billion now represent some 29.5% of NAV. We don’t have any fixed target for this segment of the market: it is necessarily opportunity driven. But it is that very opportunity which excites us: it remains our steadfast conviction that a closed ended fund is the ideal vehicle via which to access small and mid-cap companies and blend them with holdings in their larger brethren. This is the strategy which has produced good returns for our shareholders through the last five or so years and which we believe will continue to do so. 

While a number of the above stocks were purchased during the year, it is notable that Tessenderlo Chemie, Warehouses de Pauw and Veidekke make a repeat show. Of course, no table of winners should stand unchallenged: we have had some smaller cap disappointments too. Our exposure to the European cable media sector has been a particular drag, with shares in Euskaltel and NOS failing by 14.0% and 15.7% respectively during the year. Nevertheless, we remain invested in both stocks as we see potential for pricing power and strong cash generation in what remains a consolidating sector. 

From “growth” to “value” 

While forever wary of style labels, we are of the view that we are at the beginning of a major change in market leadership. For the best part of a decade investors have found comfort in so called “quality growth” stocks, prime examples being staples as well as other perceived “safe” businesses. The powerful tailwind that such stocks have received in the form of ever lower interest rates looks to have blown itself out. The corollary of this – the headwind – has been felt by the banking sector in particularly. Thus, for the first time in many a year we favour European banks in our portfolio. Rarely is this a sector for the faint hearted. Nevertheless, we believe that its lengthy bear market is ending as a combination of rehabilitated capital ratios and an inflection in interest rates makes the industry once again investable. It will be a volatile ride, not least given the European political agenda for the year ahead, but we will seek to hold on.”

HEFT : Henderson European Focus laments fickle markets

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