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European Assets slashes dividend after capital crumples

9 January 2019

High-yielding European smaller companies investment company highlights disadvantage of paying dividends from capital in a bear market by cutting its payout by 22%.

European Assets (EAT), the high-yielding European small-cap investment company, has had to slash its dividend by 22% after a slump in asset values last year.

The Netherlands-based investment company, which is popular with investors, including Investment Trust Insider’s Ian Cowie, pays out 6% of its net asset value (NAV) in quarterly dividends each year.

The level distributed is decided at the start of the year and is based on the size of its investments at the end of December.

Unfortunately for its shareholders the portfolio's NAV plunged 16.3% in euro terms last year and as a result it it will pay total dividends of 0.0684 euros per share down from 0.088 euros last year.

Charles Cade, head of investment company research at Numis Securities, said the dividend cut showed the downside of funds that paid dividends from their assets rather the income received on their investments. While payouts rose when markets advanced, the opposite occurred when markets fell.

‘However, the 22% cut in the dividend for 2019 illustrates that investors relying on funds paying dividends from capital are likely to face greater income volatility than from traditional equity income that pay covered dividends supported by revenue reserves,’ he said.

This is the first time in seven years that the company's NAV has fallen so the cut in payouts may surprise some investors. It certainly adds to the pain of investors who in sterling terms saw the value of their investment slide 15.4%, worse than the 12.7% decline in its benchmark, Euromoney Smaller European Companies ex-UK index.

Fund manager Sam Cosh said he had ‘sounded a note of caution’ at the end of 2017 about what the next 12 months had in store and reduced his ‘cyclical sensitivity and exposure to high financial leverage’.

‘While a sensible strategy, these changes were not enough to withstand the severity of some of the moves that we have seen,’ the BMO Asset Management manager said, adding that a ‘very poor April’ provided most of the underperformance.

However, he added that more volatilie markets ‘will give us opportunity to buy some good quality assets at attractive prices’ and ‘stocks are excessively cheap, discounting a somewhat more severe economic scenario that we would envisage’.

European Assets is far from alone in using capital to pay dividends. A large number of closed-end funds listed on the London Stock Exchange have adopted the strategy since a rule change more than five years ago. In an era of low interest rates, many trusts have found it a good way to attract new investors. 

Cade believes the approach has been untested by bad stock market conditions and that its shortcomings may now be revealed.

‘We also believe that paying an enhanced yield is unlikely to turnaround the fortunes of a fund with a poor performance record or where the asset class is out of favour,’ he said.

EAT's high dividends have been popular with investors helping the share price to often trade at a premium above NAV and issue new shares.

However, last May, after the tough April and as markets grew more volatile, it started to de-rate. The shares now stand at a wide discount of 9.7% below NAV, although as yet the trust has not bought back any stock. Trusts often use share buybacks to attempt to narrow their discounts.

At this low valuation European Assets shares yield nearly 9%, almost double the second highest yielding European trust.

According to Numis, since Cosh took over as lead manager in October 2011 the company has delivered an average annual total return on net of 13.9%, beating the 12.7% from the Euromoney Smaller European Companies ex-UK index. However, returns have declined markedly since before the European Union referendum. Since the start of 2016 the total return has been just 4.9% a year against 10.5% for the benchmark.

Investors will hope for a rebound if and when Brexit uncertainty is removed this year. Plans to move the company from the Netherlands to the UK and make it an investment trust may also help as the shares will become eligible investments for index-tracker funds following the FTSE All Share.

Declared in euros, European Assets' dividends are paid in pounds to holders of its sterling registered shares but in the single currency to owners of its bearer shares. The first will be paid on 31 January and the the following three at the ends of March, July and October.

Investment company news brought to you by Citywire Financial Publishers Limited.

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