BlackRock Greater Europe Investment Trust — Remaining selective in search for quality growth

BRGE’s ability to invest across the whole of Europe is a differentiating feature of the trust and Gries has a long-term focus, avoiding short-term market ‘noise’; he emphasises that he is an ‘investor in businesses, not a trader in shares’. The manager looks to align himself with the best management teams in the region that can generate long-term value for shareholders.

This approach has proved successful given the trust’s outperformance versus its benchmark and the average of its peers in the AIC Europe sector.

On 28 September 2023, BRGE’s board announced that Alexandra Dangoor would be joining lead manager Gries as co-manager of the trust with effect from the close of business on 29 September 2023. The two managers have worked closely together in recent years as Dangoor joined the BlackRock fundamental European equity team in 2019 after two years in the company’s graduate rotation program where she was an analyst in the natural resources and European equity teams. Her experience in the European equity team has enabled Dangoor to develop a deep understanding of the philosophy of running concentrated, high conviction, low turnover portfolios. BRGE’s investment objective and policy is unchanged following the appointment.

Over the last decade to 4 October 2023, BRGE’s cumulative upside capture was 115%, illustrating that the trust is likely to outperform the market in months where European ex-UK shares rally. The downside capture was 112%, suggesting BRGE tends to underperform to a lesser extent in a falling market. However, it is important to note that, the cumulative downside capture has recently increased due to a period of underperformance. Looking at the data for 10 years to the end of August 2023, the upside capture was 114%, while the downside capture was 105%. This 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 there is a disconnect between hard and soft economic data in Europe, as while purchasing manager indices and other leading indicators are weak, speaking with companies, the environment does not appear to be that bad. While Germany could technically be in a recession, the manager notes that employment is at a record high, and travel bookings and demand for other consumer services is very robust following COVID-19. Looking at the wider region, companies are nearing the end of their inventory destocking cycles following supply chain issues during the global pandemic. Gries suggests that while commentators have been calling for a hard recession in Europe over the last year, this has not materialised as the ingredients are not in place for such an outcome given that real wages are rising, employment in Europe is very strong and corporate balance sheets are healthy.

The manager emphasises his view that an investor needs to consider Europe on a stock-by-stock basis as it is difficult to take a positive view on the region as a whole. BRGE has a relatively concentrated portfolio, so it is important to avoid weak companies and sectors. European stocks performed very strongly in H123; however, global investors are still defensively positioned and underweight Europe. Gries highlights that there are some positive trends in the region: for example, he says that a capex renaissance is just beginning, led by reshoring, automation, electrification and demand for electric vehicles and alternative energy. The manager believes that the US Inflation Reduction Act is also positive for European multinational companies that have significant operations in the country.

European equities look attractively valued in both absolute and relative terms. The Datastream Europe Index is trading on a forward P/E multiple of 12.0x, which is an 18.6% discount to its 14.7x 10-year average. In relative terms, this index is trading at an 18.5% forward P/E discount to the Datastream World Index, which is noticeably much wider than the 5.7% 10-year average discount.

The performance of indices in sterling terms is shown in Exhibit 2. While, in aggregate, European shares have outperformed those in the UK over the last 10 years, both regions have significantly lagged the US market, in part due to the performance of US large-cap technology companies.

It must be remembered when considering the breakdown of BRGE’s portfolio that the geographic and sector weightings are the outcome of Gries’s bottom-up stock selection. His unconstrained approach is evidenced by several notable variances compared with the reference index.

As shown in Exhibit 3, over the year to 31 August 2023, the largest changes in BRGE’s geographic exposure were higher allocations to Ireland (+4.3pp) and France (+4.0pp) with lower weights in Denmark (-2.4pp) and Italy (-2.1pp). Versus the reference index, the largest active weights were overweight allocations to Denmark (+11.8pp) and the Netherlands (+8.6pp) with a notable underweight exposure to ‘other’ countries (-22.2pp).

Perhaps of more interest is an analysis of BRGE’s sector breakdown (Exhibit 5). Over the 12 months to end-August 2023, the largest changes were a higher technology weighting (+7.7pp) and lower allocations to financials (-3.6pp) and healthcare (-3.3pp).

There are three sectors where the trust has notable overweight exposures: technology (+14.3pp), consumer discretionary (+7.1pp) and industrials (+5.4pp). Its largest underweight positions are financials (-9.1pp) and consumer staples (-4.5pp). There are also four sectors not represented in BRGE’s portfolio as the stocks do not meet the manager’s quality growth criteria. Together, the energy, utilities, telecom and real estate sectors make up 12.6% of the reference index; a large number of the constituents of the first three sectors could be considered ‘old economy’ stocks.

At end-August 2023, BRGE’s top 10 holdings, across a range of subsectors, made up 53.4% of the fund, which was broadly in line with 53.7% a year before; seven positions were common to both periods. Analysis from Morningstar shows that the trust’s portfolio is relatively concentrated versus its peers as it has the second-highest weighting in its top 10 holdings of the seven funds in the AIC Europe sector.

BRGE’s largest position, Novo Nordisk, has been in the portfolio for more than six years. In August 2023, the company’s SELECT trial showed that its Wegovy weight-loss drug can decrease the risk of cardiovascular events by 20%. This is important given the high prevalence of deaths from cardiovascular diseases, which are very expensive to treat. Wegovy could be included in government programmes, although demand is so high that the company is currently capacity constrained. US competitor Eli Lilly has a similar drug to Wegovy in Phase III clinical trials, but the consensus view is that the obesity market is large enough to accommodate both pharma companies.

There have been no new holdings or significant disposals in the fund since our last update, which was published in June 2023.

As shown in Exhibits 5 and 6, at the end of August 2023, technology was BRGE’s largest sector weighting and had increased over the prior 12 months. This was due to both actively adding to the trust’s technology holdings, primarily funded by higher gearing, and from share price appreciation. BRGE has four semiconductor/equipment stocks: ASM International, ASML Holding, BE Semiconductor Industries and STMicroelectronics. Gries considers it is an exciting time for the sector, with high demand for its market-leading technologies. The outlook for chip manufacturing improved significantly following NVIDIA’s comments in Q223 about very high demand for semiconductors due to the growth in artificial intelligence and ChatGPT.

BRGE is the third largest of the seven funds in the AIC Europe sector (Exhibit 8). The trust’s NAV total returns are above average over the last one, three, five and 10 years, ranking third, fourth, first and second respectively. A holding in low-cost payments provider Adyen particularly detracted from BRGE’s performance in August 2023. The company reported earnings that missed consensus expectations, in part due to increased price competition in North America, which led to a 39% decline in its stock price. A difficult performance period in 2022, when growth stocks de-rated, has also negatively affected the trust’s relative positioning over the last three years. Gries comments that some of BRGE’s peers have a value bias rather than a growth bias, so are likely to have performed relatively better last year. None of the funds in the AIC Europe sector are trading at a premium to NAV. BRGE currently has the second-highest valuation in the peer group. Its ongoing charge is above average, its level of gearing is below the mean and, unsurprisingly given its capital growth rather than income objective, the trust has a below-average dividend yield.

Exhibit 10 shows BRGE’s relative performance. It has outperformed its reference index over the last five and 10 years in both NAV and share price terms. The trust has significantly outpaced the performance of UK shares over the last five and 10 years but has not kept up with the world market, which is dominated by the US (70% of the MSCI World Index) over the mid and long term.

Gries highlights that although 2022 was a tough period for growth investors, the investment backdrop has improved considerably since then. Over the last 12 months, technology has been by far the largest positive contributor to BRGE’s performance, including the trust’s holdings in BE Semiconductor Industries and ASM International. European semiconductor manufacturers and equipment companies have performed well on an improved industry outlook and are recognised for having world-leading technologies. The luxury goods sector has been a positive contributor to the trust’s performance with holdings including Hermès International, Ferrari and LVMH Moët Hennessy Louis Vuitton. However, recently the luxury goods stocks have struggled in response to poor Chinese economic data; this is despite the resilience of high-end consumers. BRGE has benefited from a lack of exposure to large defensive stocks such as Nestlé and Roche Holding that have performed relatively poorly.

Positions that have detracted from the trust’s performance over the last 12 months include biopharma life science companies such as ChemoMetec, Lonza Group and Polypeptide Group. These stocks performed very strongly during COVID due to heightened demand for their products. Their businesses have softened in a weaker economic and biotech funding environment and, like other industries, have been working through an inventory cycle. ChemoMetec’s CEO left abruptly for personal reasons, although having met the company’s new CEO, Gries is happy to continue to hold BRGE’s ChemoMetec position.

BRGE’s annual dividend has grown every year since the trust was launched in 2004 and over the last five years has compounded at an annual rate of 3.9%. Distributions are made twice a year in May and December. Typically, most of the trust’s income is generated in the second half of the financial year. So far in FY23, an interim dividend of 1.75p per share has been announced, which is in line with the FY22 interim payment. At the end of H123, BRGE had c £5.8m of revenue reserves, which is c 0.9x the last annual dividend.

Having regularly traded at a premium for most of 2021, BRGE now trades at a discount in a broad range of 2% to 8% (Exhibit 13). This situation is not unusual, as many investment trusts are trading on wider discounts than their historical averages in an environment of elevated investor risk aversion. BRGE’s 6.9% discount to cum-income NAV is towards the higher end of its 1.7% to 8.0% range of discounts over the last 12 months. Over the last one, three, five and 10 years, the trust has traded at average discounts of 5.4%, 2.3%, 3.0% and 3.5%, respectively.

Renewed annually, BRGE’s board has the authority to allot up to 10% or repurchase up to 14.99% of the trust’s shares. There are also discretionary semi-annual tender offers for up to 20% of shares outstanding, although none have been undertaken since November 2018.

BRGE was launched in September 2004 and is listed on the Main Market of the London Stock Exchange. On 21 December 2022, the board announced that Stefan Gries would become BRGE’s sole manager with immediate effect. Sam Vecht, the trust’s former co-manager, stepped down; he had been responsible for the trust’s modest emerging Europe weighting.

Gries aims to generate long-term capital growth from a focused portfolio of European equities, across the market cap spectrum, although most of the fund will be invested in companies with a market cap above €5bn. BRGE’s performance is measured against a broad Europe ex-UK index. The fund typically has 35–45 high-conviction positions and there are no constraints on sector exposure. Up to 25% of the portfolio may be held in emerging European markets (currently 0%), while up to 5% may be held in unquoted securities (currently 0%); together these two exposures may not exceed 25% of the fund. Gries may invest in debt securities (up to 20% of the portfolio – none currently held) and derivatives are permitted for efficient portfolio management. Maximum gearing of 15% of NAV at the time of drawdown is permitted.

BRGE’s stocks are selected on a bottom-up basis. Gries can draw on the broad resources of BlackRock’s Fundamental Equity division; the European Equity team alone has 20 fund managers and analysts. The first step of the investment process is idea generation, which is important in ensuring there is a continuous flow of new ideas entering the proprietary research process. A research pipeline is in place to make sure that team resources are used efficiently and to take advantage of the most promising investment opportunities.

Analysts undertake thorough industry and company analysis, looking at a firm’s market dynamics, revenue drivers, financial statements, valuations and risks to the investment thesis. It is important to understand the factors that influence a company’s share price and what the stock market is anticipating or may be missing. A proprietary research template is used to provide a consistent approach and researched stocks are assigned a rating between 1 (strong buy) and 5 (sell), while constructive debate between team members is actively encouraged.

There are four primary investment criteria when assessing a potential addition to the fund: a unique aspect – such as a product, brand or contract structure – which allows sustainable returns; options to deploy cash in areas of high and sustainable returns; a high and predictable return on capital and strong free cash flow conversion; and a quality management team with a clearly defined strategy and a strong track record of value creation.

BRGE’s portfolio currently has 34 holdings, selected from an investible universe of more than 2,000 companies. Portfolio turnover in recent years was less than 20%, which implies an average holding period longer than five years. Stocks may be sold if there is a fundamental change in the investment case that will negatively affect a company’s earnings and cash flow, if it has reached its estimated valuation target, or if a better investment opportunity is identified. While BRGE’s portfolio is concentrated, the manager and his team are risk aware and work closely with BlackRock’s independent Risk and Quantitative Analysis group to ensure the trust’s portfolio risk is closely monitored and understood.

Gries uses ESG information when conducting research and due diligence on new investments, and also when monitoring investments in the portfolio, believing that this can help enhance risk-adjusted returns. He employs both quantitative and qualitative assessments, focusing on areas including environmental risks, corporate structures and capital allocation. Given its size, BlackRock has unparalleled access to company management teams, and its managers seek to understand how firms approach ESG risks and opportunities and what potential impact these may have on their financial returns; they can encourage change when required. Gries believes that a company’s ability to manage ESG matters demonstrates strong leadership and good governance that is essential to sustainable growth. The criteria applied for BRGE’s stock selection means the portfolio is made up of businesses that score well from an ESG perspective and Gries highlights the importance of a strong corporate culture within investee companies in terms of creating value for shareholders.

At end-H123, BRGE had an available overdraft facility of the lower of £60m (reduced from £70m on 3 October 2022) or 15% of NAV, which is the maximum permitted at the time of drawdown. At end-August 2023, net gearing was 5.1%; this compares with a historical range of c 15% geared to c 10% net cash (the typical range is net gearing in a range of 5–8%). The manager does not try to time the market; the trust’s level of gearing is driven by the opportunities available for either current or new holdings.

The board negotiated a reduction in BRGE’s annual management fees. From 1 January 2023, BlackRock is paid 0.85% per year of NAV on assets up to £350m (based on the NAV at the end of each month) and 0.75% per year of NAV on assets above this level. Previously the fee was a flat 0.85% of NAV per year. It is allocated 80:20 between the trust’s capital and revenue accounts and no performance fee is payable. In FY22, ongoing charges were 0.98%, which was a 4bp reduction compared with 1.02% in FY21.

BRGE is a conventional investment trust, with one class of share. There are currently 100.8m ordinary shares in issue, with a further 17.1m held in treasury. Over the last 12 months the trust had an average daily trading volume of c 96k shares.