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Henderson European Focus annual results show in-line performance

Henderson European Focus Trust HEFT Tough Year

HEFT’s annual results – NAV provides an in-line performance

Henderson European Focus Trust (HEFT) has announced its annual results for the year ended 30 September 2018. During the year, the trust produced a net asset value total return per ordinary share of 2.0% (2017: 21.7%), which is in line with the benchmark total return of 2.0% (2017: 22.7%). However, the share price total return per ordinary share over the period was -8.6%, as the shares moved from a trading at a premium to trading at a discount to NAV. The chairman, Rodney Dennis, says that this partly reflects a deterioration in the rating of European equities, which he says also affected other peer group companies. The chairman says that the year has also been a difficult one for stock selection, with a number of HEFT’s smaller and medium sized company exposures performing poorly.

Dividend increases 5.1% year-on-year

In its annual results, HEFT’s board says that it is recommending a final dividend of 21.50p per ordinary share which, subject to shareholder approval at the AGM, will be paid on 8 February 2019. It says that, when added to the interim payment of 9.50p (2017: 9.00p) this brings HEFT’s full year dividend to 31.00p, an increase of 5.1% (2017: 11.7%) over last year’s distribution.

New fee arrangements from 1 October 2018

From 1 October 2018, HEFT’s management fee is charged at 0.65% of net assets for up to £300m of net assets, and at 0.55%for net assets in excess of £300m. While there is no immediate impact on the base management fee (as at 10 December 2018, the Company had net assets of £260.7m), the new structure is an improvement for shareholders over the previous base fee. This was charged at a flat rate of 0.65% of net assets without a tiered drop at £300m.

Performance fee removed in its entirety

HEFT says that the former performance fee arrangements (capped at a total fee (inclusive of any performance fee) of 1.3% of net assets payable in any one year) have been removed, and there is no residual amount payable under these arrangements.

In its annual results, the Board believes that these are very competitive fee arrangements for the Company and as these changes are supported by your Fund Manager, will continue to provide the requisite incentive for him to perform in both looking after the portfolio and growing the assets of the Company for the benefit of all of its shareholders.

Fund manager’s commentary on the macroeconomic backdrop

“As a fund manager I’ve never been too fond of the idea of “talking up the asset class”. In my case this would have meant extolling the virtues of European equities – a hard shift at the best of times. My reluctance hasn’t simply been down to the prospect of a daunting shift; it is due to the fact that doing so risks becoming an apologist for a region or an asset class, thereby risking at least some element of self-serving disingenuousness.  It is therefore something of a departure to use the occasion of this report to discuss “Europe”, as opposed to limiting the discussion to our own portfolio. The departure is due to what we perceive as the prospect of an inflection point on the horizon. Let’s face it, from an asset allocator’s perspective, performance of European equities has been awful. At least, that is the impression we get if we limit ourselves to that superficial measure – “the index”.

The extinction threatened breed of contrarian or mean reversionist or value investor might, at this juncture, be tempted to take the other side: he or she might plead with a disinterested audience that European equities offer a great investment opportunity. Such temptation is surely understandable when we remind ourselves that, in the world of investing, fashion plays a regular and often cruel role. Right now, it is fashionable to declare that the future belongs to “the disrupters” and the past to “the disrupted”. Indeed, one currently popular investor is predicting “a great corporate extinction”. There seems no doubt about it: Europe is home to many of these putative relics, dinosaurs and fossils: banks, telecoms, utilities, oil, pharmaceuticals; anyone?

The above, then, sets a scene of apparently interminable and well-justified underperformance by European versus US equities. And yet, a fund manager schooled in a belief that extrapolation is one of the greatest hazards to successful investing finds it terribly difficult to endorse the notion that, in markets, the past ten years is the next ten years. Based upon corporate earnings growth, Europe has deserved to underperform America. Of that there is no doubt. However, it is worth questioning whether the die really is cast.

Dear old Europe is home to a paltry number (and value) of technology companies, while America demonstrates its prowess in all things “tech”. Those of us with memories of previous boom sectors are reminded that 30% of a mainstream index has tended to mark the peak for such darlings. We are reminded of financials in the US and Europe back in the debt-fuelled, regulation-light, covenant-light days of the mid-2000s. In the UK the period was notable for Gordon Brown’s infamous “end to boom-bust”, a refrain he was happy to sing as he presided over a banking deregulation, which many believe fanned the flames of that era’s debt binge. Politicians have a canny knack of distancing themselves from the scene of the crime: much easier to let the mob bay for “greedy bankers” to deflect attention.

Investors, on the other hand, can rarely do that; we have to live with the consequences. Thus, while Chancellor and then Prime Minister Brown might perhaps look the other way when reflecting on what became of the binging banking behemoths – epitomised, some might say, by his countrymen at RBS – investors who extrapolated puffed up profits were left nursing generational losses. Oh, and taxpayers too.

Returning to today’s darlings, we recall that tech itself (then labelled “TMT” or “the new economy”) scaled the peaks of 25-30% of indices both sides of the Atlantic back in 1999-2000. There is, of course, nothing to say that tech must stop now, at 30% of American market cap. However, it is worth noting that it has doubled its weighting since 2004. It is also worth noting that 2018 was a record year for IPOs of loss-making businesses in the US equity market. The mean reversionist cannot help but reflect – that is a lot of benefit of the doubt granted to the mooted winners of the future.

The corollary is that little benefit of the doubt is being given to the widely forecast losers. We offer no resistance to the premise that many a physical retailer is unlikely to be with us in a few years’ time. Their models are indeed being hollowed out and it is a sector we simply avoid. From America’s Sears Robuck to Britain’s Debenhams and House of Fraser, the effects of digital disruption and changing consumer behaviours are in plain sight. On the Continent, not even Inditex, owner of the retailer Zara, nor Hennes & Mauritz have managed to tempt us to part with investors’ capital. Once considered growth stars these stocks too have lost their shine in recent years. It’s not the first and it won’t be the last time we’ve seen growth become value. Fashion, after all.

Yet, in the rush to embrace “the future”, we do think some babies have been thrown out with the bathwater: we think here of certain auto parts businesses such as TI Fluid Systems, one of our few UK holdings, whose shares are valuing the business at a paltry 0.7x sales and 5x EBITDA. We know we will require patience.

Europe has never been infused with – nor enthused by – the equity culture so eagerly embraced across the Atlantic. Thus, buybacks have never been that popular on the Old Continent. Nevertheless, emboldened by executive compensation schemes, together with plentiful supplies of low-cost debt, corporate America has gorged itself at the buyback feast. Add to that the bottom-line boost from equity-friendly President Trump’s tax reforms and maybe, just maybe, America’s stock market boom isn’t all down to vastly superior operating models. In other words, sufficient evidence exists to suggest that the age-old inputs – and potential nemeses – of investor crowding (fashion) artificially boosted earnings (cheap money, leverage, buybacks and tax breaks) are at work. As sure as night follows day, those factors will not always be in the investor’s favour.”

Fund manager’s commentary on the portfolio

“The year under review saw the paper and packaging sector yield good returns for our portfolio via our holdings in Smurfit Kappa (+32.0%) and UPM Kymmene (+53.3%). Having reduced our holding in Smurfit Kappa following the failed bid by International Paper, we note the subsequent share price weakness in the target company. Further weakness may well provide an opportunity to rebuild our exposure. Our holding in Marine Harvest initially tested our patience, since we were temporarily nursing losses as the weak salmon price caused investor jitters in late 2017. Our resolve paid off via a 16.8% share price rise over the year.”

Fund manager’s commentary on the performance of HEFT’s small and mid-cap holdings

“In previous Annual Reports we have used this section to laud the contribution made by our small and medium-cap selections. The year under review was more mixed in this department. On the plus side, holdings in Teleperformance (+30.5%), IMCD (+30.7%) and Diasorin (+21.3%) led the pack, while disappointments came in the shape of Tessenderlo (-22.2%), United Internet (-21.4%), Tarkett (-40.7%), Lenzing (-24.3%), Vestas (-21.5%) and Indra (-26.0%). The latter four holdings as well as Teleperformance have been sold.

Notwithstanding a disappointing year in this part of the portfolio, we continue to view small-mid caps as forming a key part of our strategy, as the table below demonstrates.

Fund manager’s commentary on outlook

“What has been outlined above is merely a picture: a picture of how we see things at this particular time in markets. Our perspective is inevitably one that is formed by, or even clouded by, a refusal to believe that trees grow to heaven. We are, of course, too chastened by experience to proclaim that a turning point is at hand, that “value” is set to outperform “growth”, that the moribund Eurostoxx 50 Index of large caps (which in our opinion is indeed home to some stranded value) is set for a comeback or that wider Europe stands on the verge of outperformance and renewed investor favour.”

Of course one ingredient which would turn things in the investment world upside down – and catalyse a resurgence of value stocks – would be the return of inflation. Here, too, we watch from the sidelines, too long in the tooth to make forecasts. But we must stay alive to the prospect.

What we are really saying is that one doesn’t need to be a diehard mean reversionist to question the zeitgeist. A combination of investor positioning, the human tendency to extrapolate, a late-stage bull market in US equities and the US economy, not to mention valuation (it never matters until it does) suggest to us that now is not the time to give up on the Old Continent – nor indeed her equities. Now is not the time to abandon a selection of so-called “value” stocks in favour of an all-out “growth” (or momentum) portfolio. Happily, Europe offers an ample selection of both styles and our investment DNA contains the pragmatism necessary to capitalise.

It is in this context that I was happy to take advantage of the Company’s widened discount (that fashion thing again) to increase my personal holding, which now stands at 333,084 shares.

Lastly, we strengthened our investment personnel substantially during the year, which included the appointment of Andrew McCarthy as Co-Fund Manager. I look forward to working with all of them in a freshly invigorated wider team and with Andrew as co-manager.

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