BlackRock Greater Europe Investment Trust — Process based on a three- to five-year view

Gries comments that 2021 was a challenging market environment, saying that it was a year of two halves. H121 saw a rally in older-economy stocks and there were broad-based earnings upgrades. The market narrative included whether inflation would be higher for longer, there were significant supply chain issues and new COVID variants emerged, so it was a tough corporate operating environment. The manager had discussed before in H221 that a high-quality management team is a very important attribute for investee companies; he says that last year was a formidable test and portfolio businesses have executed well.

Before the war in Ukraine, Gries had expected a normalisation of GDP growth and inflationary pressures to ease in 2022, along with a shift in demand from consumer goods to consumer services. However, the war has led to a new source of inflation; raw material and energy prices are expected to be higher for longer. The manager stresses the importance of investing in companies with pricing power and that can manage their supply chains. Gries says that he does not have a crystal ball and the current economic backdrop is complex; he is continuing to focus on companies with long-duration income streams. The manager’s view is that Europe has a significant energy crisis. The reduction in carbon emissions is underway and he expects the trend to accelerate, which should benefit some of BRGE’s portfolio companies. He considers that while nickel prices are rising, there is still a big incentive for a faster adoption of electric vehicles, which will be positive for semiconductor companies’ demand.

Gries explains that at the beginning of this year, there was a severe style rotation from growth/quality to value stocks that was triggered by higher oil prices and a change in central bank rhetoric, which led to an extreme repricing of relative valuations. Despite the strong top-down narratives, the manager has stuck to his longstanding investment process, with few changes to the fund; portfolio turnover was 18% in 2021, implying a five-year holding period. Gries has experienced many market rotations during his career and comments that over any meaningful time frame, it is not relative valuations but company fundamentals that drive stock prices. He has been reassessing how portfolio companies are faring in the current environment, noting that the Q421 earnings season was very strong for these businesses. They issued positive guidance; however, performance in January was ‘painful’ due to the market rotation away from the high-quality growth stocks that BRGE invests in. The manager aims to generate significant return outcomes for the trust’s shareholders but cautions that periodic drawdowns should be expected.

Vecht explains that since the fund’s inception 17 years ago, it has always had exposure to emerging European economies. These countries are more volatile and there have been several challenging periods and significant financial dislocations. His view going into February 2022 was that the Russian stock market had declined sharply, but that a war was unlikely; also, that higher oil prices would be positive for the Russian economy. The manager considered that the valuations of Russian securities were discounting bad news, which he now acknowledges was the wrong view. Before the war, BRGE’s Russian exposure was in line with the historical range (5.7% at end-January 2022, which was the fund’s largest emerging market exposure, and now valued at close to nil). Vecht visited Russia at the end of January and the common view from his many meetings with a variety of different professional contacts was that a war was highly unlikely. Following the late-February invasion of Ukraine, Russian asset prices have declined, and securities markets are closed; BlackRock has written down the value of its Russian assets to close to zero. The managers have contacted BRGE’s developed markets investee companies to discuss their Russian exposure, which is very limited overall. BRGE’s small position in Epiroc has the largest exposure with c 7% of its total sales.

Gries says that with high levels of uncertainty, investors are de-risking and there have been indiscriminate market selloffs. This is leading to attractive opportunities and an ability to pick up assets that have become undervalued in the manager’s view. He considers that global asset allocators are turning their backs on Europe; importantly, Gries says that investors do not need to be positive on the outlook for European GDP to consider BRGE. The manager cares about the earnings and cash flows of the trust’s portfolio companies and is reassured and confident that these businesses will deliver. He acknowledges that the next few months could be volatile but stresses the importance of focusing on what businesses can achieve in the next three to five years, noting that current valuations are much more attractive compared with 12–18 months ago.

As at 28 February 2022, BRGE’s top 10 holdings made up 50.9% of the portfolio, which was a higher concentration compared with 46.7% six months earlier; eight positions were common to both periods.

There have been relatively modest changes in BRGE’s sector exposures over the six months to 28 February 2022, with the largest being a higher healthcare weighting (+2.7pp) and a lower allocation to technology (-3.6pp) and energy (-3.2pp). BRGE has notable overweight exposures to the technology (+11.7pp), industrials (+7.4%), consumer discretionary (+4.3pp) and healthcare (+3.3pp) sectors. The fund continues to have no holdings in the utilities, telecommunications and real estate sectors, which collectively make up 9.7% of the reference index.

Exhibit 3 shows BRGE’s geographic exposure. In the six months to end-January 2022, there is a higher weighting to France (+3.4pp). Notable deviations versus the reference index are overweight positions in Denmark (+11.5pp) and the Netherlands (+8.6pp), with an underweight exposure to France (-7.0pp).

Gries highlights that there have been a number of severe rotations in the market in the last several quarters. He believes that once ‘you have done your homework’ you should not have to alter the fund very often. The manager says that action will only be taken if there is a severe change in a company’s investment case or better opportunities become available; he will not change the portfolio structure in response to the macro environment.

A relatively recent addition to BRGE’s portfolio is LVMH Moët Hennessy Louis Vuitton, which was funded from the sale of the holding in Kering. LVMH’s stock sold off in August/September 2021 on the announcement of the Chinese common prosperity policy, which aims to redress income inequality in the country. Gries prefers LVMH to Kering on the basis of better execution and branding, and the quality of its management team. This is one of the manager’s highest-conviction names and is in BRGE’s top 10 holdings. LVMH has been in existence for more than 100 years, so Gries believes that its heritage and history are very difficult to replicate. It acquired US jeweller Tiffany in 2021; the manager reports that the turnaround of this formerly badly managed business is going well. LVMH is increasing its market share and benefiting from a growing middle class in emerging markets and a greater number of females in the global workforce, albeit that the temporary closure of its shops in Russia will be unhelpful. To protect the value of its brands, its products are never discounted, and it is able to increase its prices every year. Gries envisages that LVMH will be in BRGE’s portfolio ‘for a long time’.

The trust has a new holding in Rational, a German manufacturer and retailer of combi steamers and ovens; these are cooking appliances that are suitable for large and commercial kitchens. Shares in this company are generally highly valued, but the manager took advantage of a period of relative underperformance due to stock market rotation in summer 2021 to initiate a position.

BRGE’s holding in Adidas was sold due to a change in the investment case. The manager lost confidence in the company as execution has been poor, including having the wrong products in the wrong place at the wrong time, while the firm has been losing share to Nike and Puma.

The manager has also been adding to some of his high-conviction positions whose share prices have fallen despite continued strong company fundamentals, such as Lonza (down c 15% year-to-date) and Sika (down c 25%), and has taken some profits in ASML.

In CY21, BRGE’s NAV and share price total returns of +30.5% and +32.2% respectively were ahead of the reference index’s +17.4% total return. Gries explains that the trust’s healthcare exposure performed relatively well, primarily due to stock selection, and made up three of the top positive contributors. Straumann (dental implants) benefited strongly from economies reopening, as in 2020 only essential medical procedures were undertaken. The manager sees considerable opportunities for the company in emerging markets including for its Invisalign teeth straightening offering and teeth whitening products. Novo Nordisk launched a new anti-obesity drug in summer 2021, which Gries believes has significant potential; he expects multiyear double-digit growth in the company’s earnings and cash flow. Novo’s business is currently split 95% diabetes and 5% anti-obesity treatments; the company has stated its intention to grow its obesity care business from DKK8bn in 2021 to greater than DKK25bn in 2025. Lonza Group is a contract manufacturer of biologics, including Moderna's COVID-19 vaccine. Gries likes the structure of the company’s contracts, while its business has high barriers to entry and the firm has regulatory approval from the US Food and Drug Administration. He says that there is strong visibility on Lonza’s future income.

BRGE’s semiconductor stocks (ASML and BE Semiconductor) have performed well due to a shortage of chips and hence strong pricing power within the industry. Gries explains that the sector can be volatile as investors have concerns that the semiconductor upcycle will end; however, the manager believes that the industry is becoming less cyclical and has more structural growth helped by digitalisation trends including increased demand for electric vehicles. Gries is positive on market leaders such as VAT Group, which is classed as an industrial company but produces valves for semiconductor manufacturers.

Stocks that detracted from BRGE’s performance in 2021 include Allegro, Neste Oil and Logitech. Allegro is a Polish e-commerce company that listed in 2020. Amazon.com has entered Poland without its Prime service and a lower product selection, but remains a serious competitor. The trust’s exposure to Allegro has been reduced. Neste Oil manufactures renewable diesel from kitchen oil and animal fats; its products are more energy efficient than normal diesel and reduce carbon emissions. While Neste has a complex process that is not easy to replicate, the competition has increased significantly, and the manager decided to exit and wait on the side lines for now. Logitech is seen as a working-from-home play; however, following a recent meeting with the company, Gries was reassured as the firm’s business trends are very strong. He has taken some profits on the position but continues to hold. The company is benefiting from the demand for online gaming, which is now one of the largest worldwide sports. While the level of business travel is unlikely to return to pre-COVID-19 levels, companies are likely to operate hybrid business models; meeting rooms are becoming better equipped with good quality audio-visual equipment, which is positive for Logitech.

BRGE’s relative returns are shown in Exhibit 6. The trust has had a tough period of performance over the last three months as investors have favoured cyclical/value stocks over those companies with attractive long-term growth profiles. More recently, BRGE’s modest Russian exposure has been detrimental. Following the Russian invasion of Ukraine, BlackRock has halted all purchases of Russian securities and written down its existing holdings, and the major index providers have removed the country from their indices. The trust retains its long-term record of outperformance and is ahead of the MSCI Europe ex-UK Index over the last one, three, five and 10 years in both NAV and share price terms.

BRGE is the third largest of seven funds in the AIC Europe sector. Although stock market rotation has affected the trust’s relative performance over the last 12 months, it continues to rank first over three, five and 10 years by a considerable margin. Gries acknowledges that BRGE will not outperform every year, especially if the stock market is led by cyclical/value stocks. The trust continues to have the highest valuation in the group; it is the only fund trading close to its NAV. It has one of the highest ongoing charges, which is modestly above the sector average, an above-average level of gearing and a dividend yield that is 70bp below the mean.