Until two years ago European Opportunities Trust (LSE: EOT), managed by Alex Darwall, was the star performer of the European sector. However, the collapse of Wirecard, its largest holding at 13% of the portfolio, was a devastating blow to the trust and to Darwall’s reputation.
What made the fiasco worse was not just the size of the holding, but also that Darwall ignored repeated dire warnings in the Financial Times of corporate misfeasance following a detailed investigation. Although he extricated some value by bailing out at the last minute, Darwall’s reputation suffered a devastating blow.
BlackRock Greater Europe (LSE: BRGE) moved up to pole position in the performance table and has remained there. The £550m trust has returned 63% over the last five years and trades at a 7% discount to net asset value (NAV). However, its growth focus has held it back over the last 12 months, in which it has lost 15%.
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Meanwhile, European Opportunities Trust, with nearly £1bn of assets, has bounced back, returning 4%. It’s second only to the £1.3bn Fidelity European (LSE: FEV), which added 5%. Fidelity European, which trades on an 8% discount, has been a consistent strong performer since its launch over 30 years ago, returning 55% over the last five years, and so remains a safe choice. If, however, Darwall has recovered his old form and learned some lessons, European Opportunities Trust, trading on a 12% discount, may be the one for the brave to invest in.
Focusing on stocks
Darwall retains his style of high conviction and low turnover. The top-ten holdings (out of 28) account for 74% of the portfolio, one of the largest being Novo Nordisk (as it is for BlackRock Greater Europe), which, alongside Eli Lilly, dominates the global market for the treatment of diabetes and therefore obesity. A third of the portfolio, much higher than for Fidelity European and BlackRock Greater Europe, is invested in the UK, including 10% each in RELX and Experian, making this a “pan-European” portfolio. Borrowings to enhance performance equivalent to 9% of net assets indicate optimism about the portfolio and a relaxed view of the market.
This view is supported by Cedric Gemehl of Gavekal, who points out that the forward price/earnings ratio of the European market has fallen from 18.3 a year ago to 12.6, slightly below the median value of the last 20 years of 13.5. The price/book ratio is right on the long-term median at 1.6 and the dividend yield at 2.9% is close to the median (3.2%).
The median implies that there is downside as well as upside, but Gemehl adds that the valuation relative to government bonds is more attractive. In the last 20 years, this has only been better in 2008, 2012 and 2020, all times of recession, so “if the eurozone economy now tips into recession and earnings fall, eurozone equities are likely to weaken further. The market’s current valuation is pricing in a sizeable economic slowdown, but not a deep recession”.
But Darwall focuses on stocks. “I invest in companies not economies. I haven’t built the portfolio on a view of inflation, but, for what it’s worth, I think inflation will be a longer-term problem. European governments have hidebound their economies with more and more restrictions – for example, the energy transition will be at higher cost – while central banks, especially in the UK, have lost the will to deal with inflation,” he says.
Darwall avoids those problems by not investing in businesses that are hurt by energy inflation, but in companies based on intellectual property that are able to deal with inflation, that can “flourish through the cycle, which competitors find hard to imitate and regulators aren’t interested in knocking”. Once he finds these companies, he sticks with them instead of playing into market rotations or trends, without trying to time the cycle. It sounds like those who gave up on Darwall two years ago should start listening.
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