James Carthew: Grab the value in Europe before the discount players do

Political and economic uncertainty is piling up in Europe and that is creating investment opportunities, particularly among smaller company investment trusts.

A year ago, I wrote an article about Saba Capital’s dealings with European Opportunities Trust (EOT ). At the time, EOT was putting together its 25% tender offer, which was taken up in full in January 2024, shrinking the trust by £221m.

Bloomberg’s shareholding data is not perfect – it suggests that Saba still has a 4% stake in the trust, but I think that is not the case. However, Bloomberg says that other discount hunters 1607, Allspring Global and City of London hold about 30%.

Since the tender, EOT has bought back another 9.3m shares, but the trust’s discount is still a bit wider than it should be at about 13%. What is needed is a turnaround in performance. However, Europe is out of favour with investors, and fund manager Alexander Darwall’s big bet on Novo Nordisk (12.7% of the portfolio at 30 November) has been a drag on returns over the past six months.

The valuation gap between the US and the rest of the world continues to expand and is starting to feel overstretched. The MSCI US index trades on about 27.5 times earnings, while equivalent indices for Asia ex-Japan, Japan and Europe ex-UK cluster around 15.5 times and the UK stands on a multiple of about 13.5.

The arguments for why the UK index is so lowly valued and why that should change have been well rehearsed, but in Europe the negatives have been piling up. With the French government in disarray, exports to Asia depressed by China’s slump, trade to the US threatened by Trump’s proposed tariffs, uncertainty over Ukraine, anaemic growth, and various election upsets, confidence is low and that should be priced into markets.

This doom and gloom is also reflected in the positions that the discount-chasing value players have in the 10 European trusts (six large-cap, four small-cap).

Against this backdrop, the best returns from the two European sectors over the past year have been delivered by two small-cap trusts. Montanaro European Smaller Companies (MTE ) – which I wrote about a couple of months ago – still retains the top spot with an underlying investment return of 16%. Running second is JPMorgan European Discovery (JEDT ), whose net asset value (NAV) is up 14.4%.

MTE’s success is interesting as it has a similar quality growth focus as EOT. Given its great long-term track record and recent return to form, it does not seem to be much plagued by discount players on its register. However, the current 13% discount is wide and feels entirely undeserved.

After a period of disappointing performance, JEDT shook up its management team earlier this year, which seems to have turned things around. It held a 15% tender offer in September which was taken up in full, shrinking the trust by £104m. Again, the buybacks have continued with about 2.1m shares or £9m worth repurchased since then.

It trades on about a 12% discount which Bloomberg suggests has attracted big stakes by the discount players. Saba is not on the list, but it was a big holder ahead of the tender and disclosed a 13.5% stake afterwards held through a total return swap – which gives it the same economic interest as a direct holding would but does not come with voting rights.

Saba’s biggest bet in the European sector is European Smaller Companies Trust (ESCT ). The activist hedge fund announced a 29% stake ahead of its AGM, but a large chunk of that (17.4%) was held through a total return swap. There was no continuation vote on the AGM agenda and Saba did not take the opportunity to lodge a resolution of its own ahead of the meeting, so it is not clear what it is up to.

Some have speculated that it plans to oppose ESCT’s continuation vote next year, or even that it is planning to seize control of one of these trusts.

At ESCT’s AGM, the voting was overwhelmingly in favour of all the resolutions put forward. However, just shy of 22% of ESCT’s shares were voted. Had Saba been so inclined, it could have blocked the reappointment of all four board directors.

Situations such as these are waking boards up to the need to engage with the retail shareholders that tend to dominate many registers but rarely vote. In the results published by BlackRock Frontier Markets (BRFI ) last week, the chairman highlighted the efforts that the board had been making to communicate with investors.

BRFI used the provisions of section 793 of the Companies Act 2006, which allows companies to find out who are the real holders of shares held in nominee names, to contact investors that hold its shares through platforms. Its aim was to encourage them to attend the AGM and/or vote their shares.

This seems eminently sensible to me. Although the platforms may baulk at the extra administration, investors’ ability to influence the direction of the companies they hold should not just be the preserve of a narrow group of discount-driven investors, which often have a much shorter-term agenda than many other shareholders.

James Carthew is head of investment company research at QuotedData.

Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances.