European investment trusts: opportunities amid trade war tension

George Cooke, Manager of Montanaro European Smaller Companies Trust, said: “Overall, the impact has been unexpectedly positive for Europe. For years, capital flows were largely one-directional – out of Europe and into the US, particularly into US mega cap technology stocks. However, the resurgence of protectionist rhetoric under the Trump presidency, including the imposition of tariffs on key trading partners and the threat of further escalation, has prompted investors to reconsider the geographic concentration of their portfolios.

“Ironically, while the political environment becomes ever more partisan, the Trump presidency has if anything driven a shift towards greater unity in Europe. Fiscal spending is going up as leaders on the continent finally agree that there is no alternative but to increase investment in areas such as defence. Investors are already responding: a recent survey showed that they made the biggest ever cut to US equity allocations in March, in favour of Europe. Given investor positioning at the end of last year, this may be only the start.”

Chris Davies, Co-Manager of Baillie Gifford European Growth, said: “Since Trump’s inauguration, we’ve seen some of the highest inflows into Europe in decades. This will probably be a product of rebalancing as the shocks to the system provided by the new administration have highlighted just how concentrated investors have become in the US market. Tariffs are, to some extent, a distraction.

“The real story in Europe is the emerging commitment to confront structural issues which have held it back over the past 17 years since the financial crisis – namely underinvestment – as a consequence of the shift in international relations. European governments, Germany in particular, have realised that they have a role in promoting growth and are looking to loosen the purse strings. Structural investment in important areas like infrastructure, energy, semiconductors and defence may encourage investors to maintain longer-term allocations to Europe in the future, particularly given that valuations remain supportive.”

Rory Stokes, Deputy Portfolio Manager of The European Smaller Companies Trust, said: “President Trump’s tariff policy has introduced a degree of uncertainty into the idea of American exceptionalism that had led to the extreme concentration in US mega cap tech. Investors have remembered the benefits of diversification and this has definitely led to a more open attitude to investing in Europe. Conferences are brimming with visitors from America looking for fresh investment ideas, along with the usual domestic crowd. Mr Trump is not the only reason that attitudes to investing in Europe have improved though. The other big driver has been the German relaxation of their fiscally restraining debt brake and a commitment to invest in infrastructure and defence.”

Jules Bloch, Co-Manager of JPMorgan European Discovery Trust, said: “We’ve seen a reassessment of the long-standing narrative of US exceptionalism and a reminder of the value of diversification. While US outperformance has been a hallmark since 2008, history shows cycles of alternating leadership are the norm. 

“Recent political shifts will have a bearing on European domestically focused companies, especially small caps, which are well positioned to benefit from any increased infrastructure investment and defence spending, while being relatively insulated from global trade tensions. Initiatives like Mario Draghi's report on reducing red tape, along with falling interest rates, rising consumer confidence, and AI-driven efficiency gains, further enhance their prospects.

“Since the November 2024 US presidential election, European small caps have already begun to reflect these favourable influences, outperforming large caps and swiftly recovering from tariff-related sell-offs. This sector's strong relative performance underscores its potential in the evolving economic landscape.”

Alexandra Dangoor, Co-Manager of BlackRock Greater Europe, said: “We have been continuously analysing the impact of the tariffs, and believe European companies with local production facilities in the US could be relative beneficiaries, whereas companies with small gross margins, such as autos, have been avoided due to their limited ability to absorb price increases. The companies we invest in tend to exhibit high margins and pricing power, allowing them to minimise the impact of tariffs.

“So far, we have been positively surprised by the resilience of company near time data. Many European and US companies have made significant multi-billion dollar investments designed to recalibrate production design mismatches. However, there remains a level of uncertainty, and many companies are understandably taking a ‘wait and see’ approach before taking more decisive action on re-adjusting their supply chains.”

Why should investors consider your trust right now?

Jules Bloch, Co-Manager of JPMorgan European Discovery Trust, said: “The investment landscape has undergone a dramatic transformation in recent months, presenting a unique opportunity for European small caps. Germany’s decision to lift borrowing constraints has released substantial funds for infrastructure and defence, giving a boost to domestic demand. Potential progress in geopolitical conflicts, alongside Mario Draghi’s report on EU competitiveness, could catalyse future reform.

“These developments are promising for European small caps. Their higher exposure to domestic revenues provides a degree of insulation from ongoing global trade tensions, while allowing them to benefit more directly from regional stimulus measures. Falling interest rates, improving real wages, and infrastructure-led fiscal policy – particularly in Germany – create a supportive environment for smaller, locally focused businesses. After a prolonged period of underperformance relative to their larger peers, valuations remain attractive, with European small caps continuing to trade at a discount to broader global markets.”

Alexandra Dangoor, Co-Manager of BlackRock Greater Europe, said: “We invest in world-class franchises that earn profits globally, and are now benefitting from the tailwind of a stronger domestic earnings contribution, driven by an improved outlook for the continent. Europe’s rate cutting cycle offers the potential for recovery in rate-sensitive sectors such as construction, where volume growth in many instances has declined to the lowest levels witnessed since the global financial crisis. We see European defence companies entering a strong and extended investment cycle underpinned by state level initiatives. Finally, European banks continue to show earnings resilience and strong capital returns, whilst remaining cheap on capital adjusted terms.

“We are positive on the outlook for the trust’s growth bias. While value has outperformed growth in Europe by around 10% so far this year, historically, a drawdown of this depth and duration in growth relative to value has tended to mark a trough in the factor cycle. We are clearly operating against a backdrop of significant uncertainty owing to US policy, but when these companies can illustrate their ability to tap into and execute on income and capex streams with strong growth, we tend to see superior returns for growth equities that enjoy the benefits of structural tailwinds.”

George Cooke, Manager of Montanaro European Smaller Companies Trust, said: “We believe the outlook for European small caps in 2025 is increasingly compelling – and the opportunity may not last forever. Valuations are currently depressed: European small caps are trading at a significant discount not only to their larger cap peers but also to their own long-term history. For most of the past 25 years, the asset class commanded a P/E premium to the broader market – reflecting its superior earnings growth and exposure to innovative, niche business models. Today, that relationship has reversed: small caps now trade at a double-digit discount, wider than during the depths of the global financial crisis, the Eurozone debt crisis, or even the Covid-19 shock. Importantly, this dislocation cannot be explained by fundamentals alone.

“This disconnect has not gone unnoticed by strategic buyers. We are seeing a marked increase in takeover activity within our portfolio – a clear signal that valuations have become too attractive to ignore. In our view, this combination of depressed valuations, improving fundamentals, and growing corporate interest creates a rare opportunity for long-term investors. European small caps may not remain out of favour for long – and when sentiment turns, it tends to do so quickly.”

Rory Stokes, Deputy Portfolio Manager of The European Smaller Companies Trust, said: “As an asset class, European smaller companies are trading at very cheap multiples, both in absolute terms but especially relative to European and US large cap companies. As the market broadens this valuation gap should narrow and that bodes well for the trust in 2025. Eurozone PMIs are beginning to pick up and once German fiscal stimulus comes through this will build further, which will make for a benign environment for European small caps. The headwinds of recent years such as the energy price shock, inflation and interest rate rises are now becoming tailwinds and this should further support the space.”

Chris Davies, Co-Manager of Baillie Gifford European Growth, said: “It’s almost impossible to predict how markets will play out over a six-month period in normal circumstances, let alone in these more volatile ones! What the trust offers is higher expected earnings growth than the market, higher returns on capital than the market and better balance sheets than the market and at a healthy discount to NAV. Those characteristics show that we have the companies which can be resilient and opportunistic in challenging times like these, and ultimately emerge stronger. This gives us confidence that we can outperform going forward.”

Marcel Stotzel, Co-Manager of Fidelity European Trust, said: “Our investment approach is to prioritise bottom-up stock selection as the primary driver of returns rather than making top-down calls or sector allocation bets. Long-term macroeconomic developments remain unpredictable and so we continue to focus on identifying companies with sustainable dividend growth, which should provide resilience in uncertain markets and deliver outperformance over the medium to long term.

“Our disciplined approach to capital preservation, sector diversification and stock selection positions the trust to navigate varied macro scenarios while maintaining focus on our long-term outperformance objective. In the event of recession, our defensive positioning should provide relative downside protection, as demonstrated historically. Furthermore, the trust’s use of gearing enables us to take advantage of the fact that markets tend to rise over the long term.”

What are the biggest risks to your portfolio?

Rory Stokes, Deputy Portfolio Manager of The European Smaller Companies Trust, said: “Near-term risks come from the tariff uncertainty of recent months causing companies to pause decision making which may well impact some companies’ order intake in the first half of 2025. Ongoing tariff negotiations and Mr Trump’s bombastic negotiating style pose direct risk too. Longer term there are geopolitical risks around the global flash points that could flare up disrupting the global economy.”

Jules Bloch, Co-Manager of JPMorgan European Discovery Trust, said: “Periods of high volatility can be challenging for mid and small cap companies. Factors like interest rate changes, inflation and geopolitical events can cause market-wide fluctuations, and in those moments, markets often move on headlines rather than company-specific performance. 

“Given this context, we focus on robust businesses with strong balance sheets and proven models which are well placed to recover once the noise settles. Crucially, our team screens over 1,000 companies across Europe to find those with the most compelling long-term potential. That breadth of research helps us stay selective and focused – even when markets are volatile.”

Marcel Stotzel, Co-Manager of Fidelity European Trust, said: “Our strategy struggles to keep pace in a market environment characterised by sharp, value-led rallies – precisely the type of short-term market conditions experienced in Q1. In general, however, we try to keep factor exposures limited so that the trust’s biggest performance driver is our stock picking. Therefore, the biggest risk to the portfolio lies in the decisions we make on which companies to hold. However, this risk is mitigated by us placing more emphasis on asking what can go wrong for an investment thesis, and our carrying out detailed due diligence work in conjunction with our team of 34 analysts who cover European stocks.”

Alexandra Dangoor, Co-Manager of BlackRock Greater Europe, said: “Ongoing tariff uncertainty and geopolitical tensions create instability and unpredictability in markets. This puts the portfolio at risk of a cyclical deterioration in spending if companies were to pause or reduce investments, damaging near-term growth prospects. Although we are aware of this risk, we do not see it as the base case scenario. Instead, we expect a weaker growth outlook than was originally expected coming into the year, but the bottom-up resilience of consumers and corporates should cushion the economy from any form of deep or prolonged recession. In addition, a redirection of investment spending allows for the global companies we invest in to potentially benefit from structurally higher spending in the US, should US policy remain focused on bringing spend back into the US.”

George Cooke, Manager of Montanaro European Smaller Companies Trust, said: “Our strategy is built around investing exclusively in high-quality, structurally growing companies. These businesses tend to have strong balance sheets, high returns on capital, and resilient business models – characteristics that have delivered strong long-term performance across market cycles. However, in the short term, such companies can lag in environments where low-quality or cyclical businesses rally sharply, which can create a headwind for our relative performance. However, the most significant long-term risk is not market timing or style rotation – it is the risk of selecting the wrong companies. In other words, the key challenge is execution: missing something in our due diligence, for instance. Fortunately we have one of the largest and most experienced teams exclusively focused on small and mid cap investing to help mitigate this.”

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