BlackRock Greater Europe Investment Trust — Long-term outperformance from high-quality fund

BRGE has a broad remit as Gries and Dangoor can seek opportunities across Europe in both advanced and developing economies. They invest for the long term, avoiding market ‘noise’ and acting as ‘investors in businesses’ rather than ‘traders in shares’. The managers contend that there are always uncertainties, so they look to align the fund with end markets that have strong income streams and companies with the best management teams that can generate long-term value for shareholders.

This approach has proved successful given the trust’s outperformance versus its reference index and the average of its peers in the AIC Europe sector over the last one, five and 10 years.

Over the last decade, BRGE’s cumulative upside capture was 111%, illustrating that the trust is likely to outperform the market in months where European ex-UK shares rally. The downside capture was 103%, suggesting BRGE tends to underperform to a lesser extent in a falling market. However, the cumulative downside capture increased due to a period of underperformance between Q421 and Q222, so the trust is probably more defensive than these figures suggest. BRGE’s favourable risk/reward profile is likely to suit investors seeking to protect their capital, while gaining exposure to an asset class that has generated excess returns over the long term compared with other major asset classes such as bonds or cash.

Gries comments that European stock markets have performed better than was generally anticipated. In H222, there was increased discussion about the risk of a European recession, with low expectations for the Q422 and Q123 corporate earnings seasons. However, earnings estimates proved to be too pessimistic, based on the negative impact of higher energy prices, and estimates were revised upwards in H123. Throughout these periods of changing investor sentiment, the manager did not change the structure of the fund and maintained his long-term views about BRGE’s investee companies. This is evidenced by the very low 16% portfolio turnover in FY23 (ended 31 August), which is equivalent to a longer than six-year holding period.

According to Gries, Q323 earnings reports were generally okay, although the operating environment in H223 is softer than expected, and economic improvement is now pushed out to 2024. He suggests that even though the European and US economies are slowing, within the household and corporate sector, the elements are not in place for a prolonged hard downturn. The manager cites high levels of employment, robust consumer spending and business trends that have been distorted by COVID-induced supply chain disruptions. Gries comments that this has been the longest talked-about recession, and many stocks are already pricing a recession in, such as banks, which are trading at a 50% discount to the European market.

In terms of valuation, the manager says that the European Stoxx 600 Index is trading on a 10.5x forward P/E, which is the lowest since the global financial crisis, so he considers that bad news is priced in to share prices. He believes there is potential for a rally in the European market as businesses that have experienced a prolonged downturn, such as chemicals and construction, show signs of improvement. Gries comments that as the stock market is a discounting mechanism, small incremental positive changes can be received very favourably by investors. He opines that when strategists’ views turn positive it will be too late, as the market will already have moved. Gries is happy with BRGE’s portfolio’s cyclical bias and below-market defensive exposure.

The manager says that the 2024 outlook is interesting, as if inflation returns to near-target levels, there is potential for central banks to lower interest rates, which could lead to a big improvement in investor sentiment. He believes that once inventory destocking comes to an end, and purchasing manager indices turn upwards, risk appetite should improve, and stocks could rerate.

For a more detailed portfolio breakdown, please see our BRGE review October 2023. At the end of October 2023, BRGE’s top 10 holdings made up 50.9%, which was a lower concentration versus 52.5% a year before; seven positions were common to both periods. There is a maximum 10% position size allowed, which the managers are discussing with the board as number one holding Novo Nordisk is approaching this limit. However, as Novo’s shares have performed so well, and the company is now the largest reference index constituent, BRGE’s holding was only 5.2pp higher than Novo’s index weighting at the end of October 2023.

Gries explains why Novo Nordisk has been so successful. It produces the semaglutide molecule, a GLP-1 agonist, which is used to treat diabetes under the brand names of Ozempic (injection) and Rybelsus (oral tablet). However, the molecule has proved to be successful in the treatment of obesity and is marketed as Wegovy (injection). Obesity is a major global issue, with very few people receiving treatment, or sticking with it due to negative side effects. Wegovy has proved to be efficacious and has a favourable side-effect profile. However, Novo’s SELECT trial also showed that the use of Wegovy could reduce adverse cardiovascular outcomes by 20%. The diabetes market is essentially a duopoly between Novo Nordisk and US-based Eli Lilly and pricing has remained disciplined, allowing both companies to generate high returns, even following new product launches. This behaviour should continue as Novo and Lilly roll out more new products as the obesity opportunity is so large that it can easily accommodate both companies and currently demand is outstripping supply. Novo’s supply constraints should ease as four new production lines come online in 2024.

Commenting on the luxury goods sector, which at the end of FY23 made up c 15% of the fund, Gries highlights differences between the trust’s holdings. He says that some companies are better at growing brands and gaining new customers than others. According to the manager, LVMH has been through a transition. Between 2010 and 2020 organic sales growth was 10% per year, which grew to 25% per year between 2020 and H123; Gries expects growth to moderate to maybe 7% to 8% in 2024. Conversely, the manager says that Ferrari is showing no signs of a slowdown; demand for its products exceeds supply, thereby affording the company significant pricing power. Gries explains that companies like Hermès and Ferrari allocate available items to their preferred customers and are expanding into new markets such as the Middle East. BlackRock has a data scientist in its investment team, who can track how brands are performing. Although, Chinese economic growth has lagged expectations, high-end spending remains robust, and the country has a favourable demographic profile due to a rising middle class.

Exhibit 3, shows BRGE’s sector and geographic splits, which are an outcome of the managers’ bottom-up stock selection. Compared with the reference index, the trust maintains notable overweight positions in technology, consumer discretionary and industrials, with a large underweight allocation to financial stocks. Four sectors are not represented in BRGE’s portfolio as companies in these sectors do not meet the managers’ quality growth criteria; the energy, real estate, telecom and utilities sectors which combined make up around 13% of the reference index.

There are seven funds in the AIC Europe sector, of which BRGE is the third largest. The trust’s NAV total returns are above average over the last one, five and 10 years, ranking second, first and second respectively. BRGE’s three-year performance has been negatively affected by a period of underperformance between Q421 and Q222 when growth stocks de-rated in a period of rising interest rates.

BRGE along with three of its peers have a capital growth, rather than a total-return mandate, but each fund has different features: Baillie Gifford European Growth can invest in both private and listed companies; BRGE has a broad remit and can invest in emerging European markets, although currently all the fund is invested in developed markets; European Opportunities Trust invests taking top-down factors into consideration; and JP Morgan Growth & Income seeks capital growth and a rising share price, but also pays dividends based on its quarterly NAV. Comparing the NAV total returns of these four funds, BRGE ranks first over the last one, five and 10 years and third over the last three years.

BRGE currently has the narrowest discount in the sector. The trust’s ongoing charge is above average, its level of gearing is in line with the mean and, unsurprisingly given its capital growth rather than income objective, BRGE has a below-average dividend yield.

In FY23, despite stock market volatility, BRGE’s NAV and share price total returns of +19.2% and +17.1% respectively were ahead of the reference index’s +15.8% total return.

The trust’s relative returns are shown in Exhibit 6. It has outperformed its reference index over the last five and 10 years in both NAV and share price terms. BRGE is significantly ahead of the UK market over the last five and 10 years, but has not kept up with the world market over the last decade. Global indices are dominated by the US (70% of the MSCI World Index), which has outperformed in most of the last 10 years.

Over the last 12 months, the largest contributor to BRGE’s performance was Novo Nordisk. Although its share price has performed very strongly over a multiyear period, Gries is happy to continue owning the stock, noting that in the 18 years that he has been covering the company, its fundamentals have never been as strong. Novo has upgraded profit expectations three times this year and the manager considers that consensus out-year estimates are too conservative.

The trust’s semiconductor exposure has been beneficial over the last year. Gries highlights BRGE’s holding in BE Semiconductor, which is one of the most profitable companies in the industry. Its new hybrid-bonding technology enables semiconductors to continue getting smaller, but more powerful and energy efficient. The manager considers that BE Semiconductor is the best European play on the growth in artificial intelligence.

Other positive contributors to BRGE’s performance over the last 12 months were not owning Roche and Nestlé, which are large-cap defensive names, and the trust’s high-end luxury exposure via its holdings in Hermès and Ferrari. The managers have also been able to sell some of BRGE’s Russian exposure that had been written down to zero, crystallising some value, for example the position in Ozon Holdings, which was held via a depository receipt rather than as sanctioned direct equity; the sale proceeds added 0.6% to NAV.

On the negative side, over the last 12 months, the trust’s life sciences exposure has detracted from its performance, namely the holdings in Lonza Group, ChemoMetec and Sartorius Stedim Biotech. Gries comments that following COVID, high inventories have been worked down and there have been some areas of demand weakness, such as in early-stage biologics. The manager believes that life science business conditions have troughed, and he expects an order pickup in Q423 and into 2024, with a resumption of 10–15% annual industry growth.

BRGE’s position in low-cost payments provider Adyen has been disappointing. The company lowered its growth guidance in Q223 based on a more competitive US pricing environment. On the day of the announcement, Adyen’s share price declined by 45%. The company’s Q323 results exceeded expectations and its share price is now recovering; the managers are continuing to evaluate Adyen’s future prospects.