Fidelity European Trust plc (LON:FEV) has announced its final results for the year ended 31 December 2022.
Financial Highlights:
- The Board of Fidelity European Trust recommends a final dividend of 4.62 pence which together with the interim dividend payment of 3.08 pence per share (totalling 7.70 pence) represents an increase of 12.7% over the total dividend of 6.83 pence paid in the prior year.
- Over the reporting year, the net asset value of the Company returned -3.6% but outperformed the Benchmark Index which fell by -7.0%. The share price return was -3.8%.
- The Company was the top performer in its peer group at the end of the reporting year.
- The Company continues to focus on attractively valued companies with strong balance sheets and consistent dividend growth.
CHAIRMAN’S STATEMENT
The year under review was one of the most extraordinary in recent memory, rivalling the one in which COVID-19 first erupted. It is barely a year since Russia invaded Ukraine, devastating an entire country and sending shockwaves around the globe. Everything from grain to oil prices, energy and commodity costs and spending on defence, were impacted. The UK had three prime ministers in the space of a few months, while Continental Europe saw a new ruling coalition in Italy and a tightly contested election in France. Meanwhile, central banks raised interest rates significantly and moved from quantitative easing to quantitative tightening. The European Central Bank was somewhat later than others to embark on this important change of policy.
With so much going on, one would be forgiven for overlooking the impact that COVID-19 has had on consumers and businesses. Having said that, China announced a surprising end to its zero-COVID policy in December 2022, potentially opening up one of the world’s major economies again and benefiting demand for European companies’ products. With elevated levels of volatility and a difficult market environment, the Board and I are pleased to see the Portfolio Managers sticking to their tried and tested philosophy of bottom-up stock picking, namely finding attractively valued dividend growers with strong business franchises and balance sheets.
Performance
The Company’s performance, although negative over the period, was better than the Benchmark Index, the FTSE World Europe (ex-UK), with a net asset value “NAV” total return of -3.6% and a share price total return of -3.8%. In comparison, the Benchmark Index total return was -7.0%. The discount widened slightly from 5.1% at the start of the year to end the year at 5.4%. Both the NAV and share price total performance returns over three, five and ten years remain well ahead of the Benchmark Index, as can be seen from the chart on the Financial Highlights page in the Annual Report. These are pleasing results for the Company.
Outlook
Inflation appears to have peaked in Europe at 10.6% in October 2022. The last quarter of 2022 saw equity markets bounce given unusually mild weather in Europe which helped bring down gas prices from elevated levels, and of course, positive news from China where property market stimulus and a relaxation of zero-COVID policies helped to buoy markets. In Europe, results for the third quarter also held up better than expected, in part supported by a weak euro.
The risks of a global recession at some stage in 2023 loom large, however, and so there is a tone of caution about the operating environment for the year ahead. Companies with prudently managed balance sheets look well-positioned to weather any potential economic problems, and it is exactly these types of resilient companies in which the Company’s Portfolio Managers look to invest.
The portfolio remains balanced in terms of sector positioning and the Portfolio Managers’ focus is on finding attractively valued companies with good prospects for cash generation and dividend growth over the longer term. Positioning is driven by opportunities at the individual stock level rather than by macro developments, as the Portfolio Managers believe that calling the general direction of the market is a difficult, if not an impossible task. The investment strategy of the Company remains unchanged.
Environmental, Social and Governance (ESG) Investment
ESG factors remain central to the work of both the Board and the Portfolio Managers. Businesses are under pressure to ensure that their activities are environmentally sustainable and demonstrate social responsibility and good corporate governance. Although there is progress in the form of commitments and initiatives across a wide range of areas from deforestation to clean energy transition, much more needs to be done. Continuing deterioration in the climate and other ESG concerns present their own investment risk to your portfolio. Fidelity International has a sustainable investing approach, including engagement and voting principles and guidelines. It continues to evolve its approach to ESG, for example, in its proprietary forward-looking ESG ratings. The proprietary sustainability ratings system leverages Fidelity International’s internal research and interactions with issuers, and the ratings are designed to generate a forward-looking and holistic assessment of ESG risks and opportunities based on sector specific performance indicators. Analysts quantify the direction of change of companies’ ESG performance and rate the companies using a scale of A to E. The ratings of the companies within the portfolio are well ahead of the broader market and continue to improve.
The Portfolio Managers outline how they use Fidelity International’s approach to ESG in their report and what this means for the Company’s investment portfolio. The Fidelity group of companies (including the Manager) has embedded ESG factors in its investment decision making process. Further details are in the Annual Report.
OTHER MATTERS
Dividends
The Board does not influence the Portfolio Managers by imposing any income objective in any particular year, and the investment focus on companies capable of growing their dividends remains. The Board acknowledges that both capital and income growth are components of performance, as reflected in the investment objective of the Company. It therefore has a policy whereby it seeks to pay a progressive dividend in normal circumstances and to pay dividends twice yearly in order to smooth dividend payments for the reporting year. Unlike open-ended funds, investment trusts can hold back some of the income they receive in good years, thereby building up revenue reserves, which can then be used to supplement dividends during difficult times. The Board has over the past few years augmented revenue reserves by retaining a small proportion of earnings to be used in difficult times, as in the case of the final dividend paid in May 2021.
The Company’s revenue return for the year to 31 December 2022 was 9.00 pence per ordinary share (2021: 7.50 pence), and an interim dividend of 3.08 pence per ordinary share was paid on 28 October 2022 (2021: 2.65 pence). The Board recommends a final dividend of 4.62 pence per ordinary share for the year ended 31 December 2022 (2021: 4.18 pence) for approval by shareholders at the Annual General Meeting (“AGM”) on 10 May 2023. The interim and final dividends (total of 7.70 pence) represent an increase of 0.87 pence (12.7%) over the 6.83 pence paid for the year ended 31 December 2021.
The final dividend will be payable on 16 May 2023 to shareholders on the register at close of business on 31 March 2023 (ex-dividend date 30 March 2023). Shareholders may choose to reinvest their dividends for additional shares in the Company.
Discount Management and Treasury Shares
The Board has an active discount management policy, the primary purpose of which is to reduce discount volatility. It seeks to maintain the discount in single digits in normal market conditions. Buying shares at a discount also results in an enhancement to the NAV per ordinary share.
In order to assist in managing the discount, the Board has shareholder approval to hold ordinary shares repurchased by the Company in Treasury, rather than cancelling them. Shares in Treasury are then available to be re-issued at NAV per ordinary share or at a premium to NAV per ordinary share, facilitating the management of and enhancing liquidity in the Company’s shares. The Board is seeking shareholder approval to renew this authority at the AGM on 10 May 2023.
Between August and October 2022, as the Company’s discount widened, it repurchased 2,285,526 ordinary shares into Treasury. Since then the discount has remained in single digits and no further shares have been repurchased.
Gearing
The Company continues to gear through the use of derivative instruments, primarily contracts for difference (“CFDs”), and the Portfolio Manager has flexibility to gear within the parameters set by the Board. As at 31 December 2022, the Company’s gross gearing was 11.7% (2021: 11.1%). Net gearing was the same at 11.7% (2021: 11.1%) due to the absence of any short derivative positions in the portfolio. In the reporting year, gearing made a negative contribution to performance, as can be seen from the attribution analysis table in the Annual Report.
The Board monitors the level of gearing and the use of derivative instruments carefully and has defined a risk control framework for this purpose which is reviewed at each Board meeting. It should be stressed that all gearing is subject to the Portfolio Managers’ confidence in identifying attractive investment opportunities, and to their remaining attractive.
Board of Directors
After serving on the Board for nine years, Marion Sears stepped down from the Board on 10 May 2022 as a non-executive Director and Senior Independent Director. Her successor as a non-executive Director, Milyae Park, was appointed on 1 January 2022. Milyae was subsequently elected by shareholders at the AGM held on 10 May 2022. Paul Yates succeeded Marion as Senior Independent Director on 10 May 2022.
We continue to review Board composition and Directors’ succession on a regular basis to ensure that we have a Board with a mix of tenures and one which provides diversity of perspective together with the range of appropriate skills and experience for your Company. In accordance with the UK Corporate Governance Code for Directors of FTSE 350 Companies, all Directors will be subject to annual re-election at the AGM on 10 May 2023. The Directors’ biographies can be found in the Annual Report and between them they have a wide range of appropriate skills and experience to form a balanced Board for the Company.
Continuation Vote
In accordance with the Company’s Articles of Association, the Company is subject to a continuation vote every two years. The next such vote is at this year’s AGM on 10 May 2023.
The Company’s performance record has been strong since it launched on 5 November 1991, with a NAV total return of 4,899.3% and a share price total return of 4,784.6% compared to a Benchmark Index total return of 1,280.5%. The NAV and share price returns over one, three and five years remain well ahead of the Benchmark Index as can be seen from the “Standardised Performance Total Return” chart on the Financial Highlights page in the Annual Report. In addition, the prospects of the Company over a five year investment horizon can be found in the Viability Statement below. Therefore, your Board recommends that Shareholders vote in favour of the continuation of the Company.
Annual General Meeting
The Company’s AGM is at 12 noon on Wednesday, 10 May 2023, and the Board and I hope to see as many shareholders as possible. Details of the AGM are below.
Vivian Bazalgette
Chairman
20 March 2023
ANNUAL GENERAL MEETING – WEDNESDAY, 10 MAY 2023 AT 12 NOON
The AGM of the Company will be held at 12 noon on Wednesday, 10 May 2023 at 4 Cannon Street, London EC4M 5AB (nearest tube stations are St Paul’s or Mansion House) and virtually via the online Lumi AGM meeting platform. Full details of the meeting are given in the Notice of Meeting in the Annual Report.
For those shareholders who would prefer not to attend in person, we will live-stream the formal business and presentations of the meeting online.
Sam Morse, the Portfolio Manager, will be making a presentation to shareholders highlighting the achievements and challenges of the year past and the prospects for the year to come. He, the Co-Portfolio Manager and the Board will be very happy to answer any questions that shareholders may have. Copies of his presentation can be requested by email at [email protected] or in writing to the Company Secretary at FIL Investments International, Beech Gate, Millfield Lane, Lower Kingswood, Tadworth, Surrey KT20 6RP.
Properly registered shareholders joining the AGM virtually will be able to vote on the proposed resolutions. Please see Note 9 to the Notes to the Notice of Meeting in the Annual Report for details on how to vote virtually. Investors viewing the AGM online will be able to submit live written questions to the Board and the Portfolio Managers and we will answer as many of these as possible at an appropriate juncture during the meeting.
Further information and links to the Lumi platform may be found on the Company’s website at www.fidelity.co.uk/europe. On the day of the AGM, in order to join electronically and ask questions via the Lumi platform, shareholders will need to connect to the website https://web.lumiagm.com.
Please note that investors on platforms, such as Fidelity Personal Investing, Hargreaves Lansdown, Interactive Investor or AJ Bell Youinvest, will need to request attendance at the AGM in accordance with the policies of your chosen platform. They may request that you submit electronic votes in advance of the meeting. If you are unable to obtain a unique IVC and PIN from your nominee or platform, we will also welcome online participation as a guest. Once you have accessed https://web.lumiagm.com from your web browser on a tablet or computer, you will need to enter the Lumi Meeting ID which is 186-425-859. You should then select the ‘Guest Access’ option before entering your name and who you are representing, if applicable. This will allow you to view the meeting and ask questions, but you will not be able to vote.
Portfolio Managers’ Review
Question
You have both had another year of navigating challenging investment conditions under your belts. What lessons have you learned?
Answer
Sam:
1. Expect the unexpected. We do not spend a lot of time trying to predict what comes next (did you predict the global pandemic or the invasion of Ukraine?) but we do spend a lot of time trying to identify well-funded companies that we think will be able to deliver consistent dividend growth irrespective of what comes next.
2. Stay fully invested. The first portfolio manager of your company, Anthony Bolton, always reminds us that it is important not to become more bearish as the market falls. The stock market looks forward and often recovers its poise when investors least expect it.
3. Stay balanced. Diversification is a free gift – it provides protection from unexpected outcomes and reduces the number of sleepless nights in times of high volatility (which has been the norm in 2022 and recent years.)
Marcel: I fully agree with all that Sam has mentioned. I would add that sometimes when it comes to trading during periods of crisis “less is more”. This runs counter to the conventional wisdom that you need to trade more during these periods in order to protect your portfolio. We were not smart enough to predict the pandemic and invasion of Ukraine and all the second and third order impacts. However, when we looked at the Company’s holdings individually, as well as in aggregate, we felt confident that the Company was well setup to handle what the market would potentially throw at us. This indeed proved to be the case and vindicated our approach to avoid “doing something” just for the sake of it.
Question
What stocks have performed particularly well during this period and why?
Answer
Sam: As the old saying goes: ‘You wait forever for a London bus and then three come along one after the other.’ The Company had not had a takeover offer for one of its holdings for some time, but in 2022, we received three offers which, on a combined basis, accounted for much of the NAV outperformance of the Company, relative to its Benchmark Index. The most significant boost to performance came from Swedish Match for which Philip Morris International (think Marlboro man) originally offered SEK106 per share in May and ended up giving us SEK116 per share six months later. Although we did not think it was overly generous, we decided to accept the SEK116 offer. Swedish Match has been a dividend growing stalwart in the Company for many years and has enjoyed a lot of recent success in the USA. We expect this to continue with its nicotine pouch brand Zyn. Atlantia, the Italian infrastructure company, was taken over by the Benetton family who already had a controlling stake in the company, in league with the private equity giant Blackstone. Finally, at the end of the year, Novozymes, a major player in industrial enzymes, announced an all-Danish ‘merger’ with another holding in the Company, Christian Hansen, a major player in food enzymes and cultures.
| Top 5 Stock Contributors (on a relative basis) | % |
| Swedish Match | +1.6 |
| TotalEnergies | +1.1 |
| Novo Nordisk | +0.7 |
| Deutsche Börse Group | +0.7 |
| Bankinter | +0.7 |
| ========= |
| Top 5 Stock Detractors (on a relative basis) | % |
| Partners Group | -0.8 |
| EQT | -0.6 |
| Legrand | -0.6 |
| Novartis | -0.6 |
| Dassault Systèmes | -0.5 |
| ========= |
Question
What impact has heightened geopolitical risk had on the Company?
Answer
Marcel: Clearly, the primary impact has been that the sense of security which the market, and indeed society at large, has had for a number of years, has been shattered as a result of the largest European conflict since 1945. As such the “peace dividend” that markets have enjoyed over many years is substantially reduced with the market now also repricing risks of not just Eastern Europe but also other regions such as Taiwan and Korea. Additionally, the second order impact of the Ukraine invasion has been materially higher inflation and interest rate expectations over the coming years. All of the above has resulted in a sharp de-rating in the market, even if at an aggregate level, European corporate earnings are still expected to grow in 2023.
Question
How optimistic are you about corporate earnings?
Answer
Marcel: The short answer is less optimistic than sell-side consensus estimates. Surprisingly to us, consensus still expects earnings growth in 2023 for European listed equities in aggregate, despite the challenging macroeconomic outlook and likely headwinds over the next 12 months. Fidelity’s analysts in aggregate are more bearish, expecting earnings to decline by 5%+ in 2023, with which we would agree. Additionally, there is likely to be more downside risk to these earnings numbers than upside risk. Having said this, we believe aggregate earnings in the Company should prove to be more resilient than the market given we can seek shelter in sectors with pricing power, balance sheet strength and tailwinds from structural demand and a strong US dollar. Key sector examples of this would be luxury goods, software and aerospace and defense.
Thus, Fidelity analysts are less optimistic than the market on earnings growth for European companies in 2023, but the stocks in the portfolio should prove more resilient (see chart in the Annual Report).
Question
What are some of the more recent portfolio changes that you have made and how are you positioned for 2023?
Answer
Sam: For much of 2022, we have been sitting on our hands. Turnover has been low. Although we have seen some big drops in the share prices of high growth companies, owned and not owned, we must not forget that, in many cases, they were dropping from very elevated levels (a corollary of ultra-low interest rates). Towards the end of the year, however, we did begin to add selectively to existing holdings which might be categorised as ‘growth cyclicals’ with a particular focus on those with strong balance sheets, given our expectation that interest rates would stay high in 2023 and that we might experience a more recessionary environment too. We used the proceeds from Swedish Match and Atlantia to add to our holdings in ASML, Partners Group and Kone – all of which have been derated aggressively during 2022, but all of which enjoy strong balance sheets and retain, in our opinion, strong long term prospects for dividend growth. We also have some high growth stocks on our watch list that are not currently owned by the Company, but have fallen to more attractive entry levels, having been overly expensive for many years, so we expect to see more turnover in the Company in early 2023 relative to recent years. Our focus, in terms of positioning, is the same as always: we will stay balanced by sector groupings and stay anchored on well-funded companies which are able to grow their dividends consistently on a three to five year view.
QUESTION
Markets went down last year. Why did you stay geared?
Answer
Sam: In keeping with Fidelity’s long-held conviction that it is a “mug’s game” to try to time markets, Marcel and I will, with the Board’s endorsement, maintain a fixed level of gearing within a 10%-15% range. The agreed level of gearing takes into account our cautious investment approach and allows considerable headroom in the event of a sharp sell-off in the market. Gearing is, of course, one of the great advantages of an investment trust, and although it may amplify volatility in the short term, we expect it to enhance long term returns. Yes, it is painful when markets fall, as they did in 2022, and it is often tempting to reduce the gearing when that happens, but markets do recover and often when least expected. If you miss out on those early days of recovery, you may fail to gain all the potential benefit of gearing.
Question
What headwinds do you see facing the portfolio in the next 12 months?
ANSWER
Sam: The health of the consumer is critical especially in more mature economies where private consumption often represents the majority of GDP. The inflation shock of 2022 will continue to be a headwind for most consumers in 2023. It is unlikely that wages will rise as fast as the cost of living so disposable incomes will be squeezed again in real terms. Rising unemployment could also add fuel to the fire. Many of the companies we own in the Company’s portfolio, especially those that are consumer-facing, will suffer a headwind of declining demand and they will have to work hard to off-set the forces of operational leverage if they are to avoid seeing a geared negative impact on their bottom line. Pricing power will continue to be an important antidote in this battle, particularly while inflation remains elevated. As mentioned at last year’s AGM, we have always focused on pricing power as an enabler for delivering consistent dividend growth. There are many examples of pricing power across the Company’s holdings. Some have products with inelastic demand, such as Hermes handbags, some sell ‘small but critical’ products, such as the food ingredients sold by Symrise, and some enjoy pricing power thanks to their dominant position in their industry, such as ASML.
Question
Are you planning to make any changes to your investment approach?
Answer
Sam: No. Companies that deliver consistent dividend growth consistently outperform those that do not. Backward-looking analysis demonstrates that this is true. The challenge, of course, is to be able to identify which companies will grow their dividends consistently going forward – and in this respect, the past is not necessarily always a reliable guide. We focus on certain key criteria to help us identify which companies will grow their dividends on a three to five year horizon. We look for positive fundamentals, such as proven business models that enjoy attractive cash flow returns on cash invested, a strong balance sheet (we certainly want to avoid companies where financial leverage could jeopardise their ability to grow dividends) and strong cash generation (a good track record in cash generation usually goes hand in hand with a good track record in dividend growth). Finally, we try to make sure we do not pay too much for the dividend growth we expect – this is not dividend growth at any price but dividend growth at an attractive or, at least, a reasonable price. Our investment strategy will not change but we are always trying to improve our execution of that strategy!
Question
How have you taken advantage of developments in Fidelity’s approach to ESG this year?
Answer
Marcel: Fidelity’s recent evolution of its proprietary ESG ratings framework (see the Annual Report) has resulted in our ESG analysis going much deeper than before and with additional focus on the comparability of stocks across various sectors and geographies. While the Company is not an ESG fund, we do clearly use ESG factors as an input. Put simply we view “sustainability” and the “sustainability of dividends” as very closely related concepts. Given our longer than average holding periods, we do not want to be taking any undue ESG risks: these risks might come to light while we own the stocks! As such we have welcomed the increased depth of ESG analysis as it allows us more accurately to evaluate the ESG risks or relative lack thereof on the Company’s holdings. An example of this would be aerospace and defense, which is a sector that is sometimes shunned by investors given the defense exposure most companies have. Events over the last year, however, have shown how a more nuanced approach is required than simply excluding defense exposed stocks outright and as such the deeper dive on ESG for MTU Aero Engines was invaluable. It uncovered MTU as one of the best global ESG aerospace and defense stories (without many of the typical red flags the industry faces), which was part of what gave us the confidence to increase our holding in the company.
Below, we share a voting case study on TotalEnergies.
SAM MORSE
Portfolio Manager
20 March 2023
Marcel Stötzel
Co-Portfolio Manager
20 March 2023
TOTALENERGIES: VOTING CASE STUDY
BACKGROUND
French oil major TotalEnergies is a high conviction holding in Fidelity European Trust PLC’s portfolio. At Fidelity, we take our ownership of companies seriously and actively vote on shareholder resolutions, a process which is driven by our sustainable investing team, who act in consultation with the portfolio managers and investment analysts. Fidelity engaged with the company before an advisory shareholder vote on its sustainability and climate transition plan at its 2022 AGM, using the insights gleaned to conclude that TotalEnergies’ progress merited support on balance. This decision corresponds with our view that TotalEnergies is making positive strides with its transition plan, further bolstering our conviction in the stock.
A HIGH CONVICTION HOLDING
TotalEnergies is a core holding in the Fidelity European Trust PLC portfolio and we have long liked the company for its low-cost upstream portfolio, large integrated chemicals footprint, good asset mix and strong capital allocation policies. Importantly for us, the company has a strong balance sheet and solid shareholder distributions, with a 6% dividend yield and a dividend per share that is growing at 3-5% a year. Further strengthening our conviction in the stock is the fact that the company is ahead of its peers when it comes to transforming its business for a low carbon future.
DUE DILIGENCE INFORMS OUR VOTING DECISION
In May 2022, TotalEnergies held an advisory shareholder vote on its sustainability and climate transition plan as part of its 2022 AGM. Shareholder voting is a process that is driven by our sustainable investing (“SI”) team, in consultation with the fundamental analyst covering the stock and the portfolio managers who own it. As is typical, for the TotalEnergies shareholder vote, we were consulted by the SI team in advance, who outlined to us their intentions and the reasons why they intended to vote in favour of the plan.
Our SI team and the investment analyst told us that they believed TotalEnergies had a well-articulated climate transition plan, including a description of how it expects its portfolio mix to look in 2050 to reach net zero. Renewable electricity is to account for 50% of production, new decarbonised molecules from biomass or from renewable electricity will account for 25%, and hydrocarbons will account for the remaining 25%, with residual emissions fully captured, recycled or offset. TotalEnergies has also been able to set more ambitious scope 3 targets than the sector, largely through a pivot to LNG and electricity. Our SI team and fundamental analyst pointed out that TotalEnergies is the only oil major whose long term targets/pathway are currently deemed net zero aligned by the Transition Pathway Initiative. TotalEnergies also articulates how its capital allocation aligns to its climate strategy, and a substantial level of its management’s remuneration incentives are linked to climate objectives.
Our SI team and analyst also engaged with the company before reaching a final voting decision. This was partly to address the concern about the board’s decision to exclude a climate-related shareholder proposal from the agenda. The board had deemed the resolution to be inadmissible due to encroaching on the board’s duty to set strategy, a matter of settled law in France. Although our SI team and analyst were satisfied with the company’s explanation, they have emphasised that this is an issue they will keep under review.
A BROADER VANTAGE POINT
TotalEnergies has clearly made progress on decarbonisation, but it is important to acknowledge that the oil industry as a whole is not yet on a decarbonisation path that would result in meeting the goals of the Paris Agreement. The issue is clearly complex: the vast majority of the sector’s emissions come from clients over which TotalEnergies and others do not have direct control, so achieving net zero will only be possible with determined engagement from the industry, clients’ willingness to adapt, and a supportive broader environment, including government cooperation at an international level. Change in demand for fossil fuels caused by the war in Ukraine may also impact the ability to meet near term emissions reduction targets.
These are constraints that our SI team took into consideration when deciding how to vote on TotalEnergies’ shareholder motion, and these are, of course, also issues we take into consideration when assessing how viable and attractive our Company’s portfolio holdings business models are. The SI team made it clear to us that their voting decision was based on an assessment of what companies throughout the industry are doing to contribute to global decarbonisation now, and how they are positioning themselves for the requirements of a low carbon economy in the future, drawing comparisons with competitors and globally accepted decarbonisation frameworks.
Based on their engagement with and the assessment of the company, our SI team concluded that TotalEnergies’ progress merited support on balance.
STRENGTHENING OUR CONVICTION
Our SI team’s assessment of TotalEnergies’ approach to decarbonisation, their engagement with the company, and the consideration of broader industry dynamics, all strengthened our view that TotalEnergies is among the leading oil majors when it comes to decarbonisation strategy, targets, and reporting. It is at a more advanced stage than sector peers in terms of decarbonisation and portfolio diversification, and its climate objectives are the strongest. All of this bolsters our conviction in the stock, confirming our view that the company not only has strong fundamental characteristics, but that its proactive approach to decarbonisation gives us confidence that it is focused on ensuring its business will remain viable in the years to come.
Strategic Report
RISK FRAMEWORK
Principal Risks and Uncertainties and Risk Management
As required by provisions 28 and 29 of the 2018 UK Corporate Governance Code, the Board has a robust ongoing process for identifying, evaluating and managing the principal and emerging risks and uncertainties faced by the Company, including those that could threaten its business model, future performance, solvency or liquidity. The Board, with the assistance of the Alternative Investment Fund Manager (FIL Investment Services (UK) Limited/ the “Manager”), has developed a risk matrix which, as part of the risk management and internal controls process, identifies the key existing and emerging risks and uncertainties that the Company faces. The Audit Committee continues to identify any new emerging risks and take any action necessary to mitigate their potential impact. The risks identified are placed on the Company’s risk matrix and graded appropriately. This process, together with the policies and procedures for the mitigation of existing and emerging risks, is updated and reviewed regularly in the form of comprehensive reports considered by the Audit Committee. The Board determines the nature and extent of any risks it is willing to take in order to achieve the Company’s strategic objectives.
Climate change, which refers to a large scale shift in the planet’s weather patterns and average temperatures, continues to be a key emerging issue as well as a principal risk confronting asset managers and their investors. The Board notes that the Manager has integrated ESG considerations, including climate change, into the Company’s investment process. Further details are in the Annual Report. The Board will continue to monitor how this may impact the Company as a risk on investment valuations and potentially shareholder returns.
Other emerging risks may continue to evolve from unforeseen geopolitical and economic events, in addition to those currently being faced globally, such as the energy supply crisis, the cost of living crisis, rising inflation, food supply crisis and cyberattacks on critical infrastructure.
The Manager also has responsibility for risk management for the Company. It works with the Board to identify and manage the principal and emerging risks and uncertainties and to ensure that the Board can continue to meet its UK corporate governance obligations.
The Board considers the following as the principal risks and uncertainties faced by the Company.
| Principal Risks | Description and Risk Mitigation |
| Economic and Geopolitical Risks | The Company and its assets may be impacted by economic and geopolitical risks, in particular concerns over global economic growth, inflation and financial distress. Inflation remains elevated across most economies driven by a combination of increased demand, as the pandemic restrictions are lifted, global labour shortages in some sectors, supply chain shortages and ramifications of the Russia-Ukraine war. This weighs on European stocks, as does the progressive raising of interest rates by the European Central Bank and the Bank of England. The economic impact from the war in Ukraine is significant and threatens consumer spending and industrial activity amid soaring energy costs and currency instability. Volatile gas prices on lower supply raises the risk of a European recession and weighs heavily on industry and production, and although financial markets have now largely priced in this risk, the outlook remains uncertain. A settlement of the conflict in the short term looks unlikely. In the meantime, significant macro and geopolitical effects will continue to need to be managed. The expected growth in global GDP has already been revised downwards in 2022 since Russia’s invasion. Monetary tightening by the European Central Bank and the Bank of England heightens risks of default for highly leveraged businesses amid recession concerns. The Federal Reserve’s hike in interest rates further strengthens the US dollar, whilst political turmoil and quantitative tightening in the UK may further exacerbate the UK sterling foreign exchange rate and yield volatility. Globally, geopolitical uncertainty is significantly impacted by deglobalisation trends driven by the prioritisation of the resiliency of supply chains as well as from political pressure. The ramifications of onshoring include regulatory protectionism across regions, heightening geopolitical tensions on the continent and overseas. US-China tensions over trade and technology rivalry increase the concerns of China-Taiwan relations escalating to military conflict and potential defence implications to other countries. More fragmented global order increases the geopolitical importance of trade agreements. The Board reviews economic and geopolitical risks and legislative changes at each Board meeting. The Portfolio Manager, with support from the Co-Portfolio Manager, provides an investment review at each meeting which includes a review of the economic and political environment and any risks and challenges faced by the Company. The Company has no direct investments in Russia and Ukraine. Whilst the companies in the portfolio are exposed to these risks, most of these companies are global businesses and therefore, also exposed to global economic trends. The Chairman’s Statement and the Portfolio Managers’ Review above provide more detail. |
| Market Risk | The principal market related risks are financial market related such as market downturns, interest rate movements, inflation, exchange rate movements and market shocks such as the post pandemic economic recovery and volatility from the war in Ukraine. Russia and Ukraine are both significant net exporters of oil, natural gas and a variety of soft commodities, and supply limitations are fuelling global inflation and economic instability. This is leading to prolonged cost- of-living crisis risks and potentially impacting investors’ risk appetite. Inflationary pressures may last longer than central banks or governments may like. COVID continues to be a global pandemic with the potential for severe market and economic impacts with future variants. The risk of the likely effects of the pandemic on the markets are somewhat mitigated by the Company’s investment trust structure which means no forced sales need to take place to deal with any redemptions. Therefore, investments can be held over a longer time horizon. The Portfolio Managers’ investment philosophy of stock-picking and investing in attractively valued dividend growers with strong balance sheets should continue to outperform the Benchmark Index over time. Risks to which the Company is exposed in the market risk category are included in Note 17 to the Financial Statements below together with summaries of the policies for managing these risks. |
| Discount Control Risk | Due to the nature of investment companies, the price of the Company’s shares and its discount to NAV are factors which are not totally within the Company’s control. The Board has an active discount management policy in place, the primary purpose of which is to reduce discount volatility and maintain the Company’s discount in single digits in normal market conditions. Some short term influence over the discount may be exercised by the use of share repurchases at acceptable prices and within the parameters set by the Board. The demand for shares can be influenced through good performance and an active investor relations program. The Company’s share price, NAV and discount volatility are monitored daily by the Manager and the Company’s Broker and considered by the Board at each of its meetings. |
| Operational Risk from Cybercrime | The operational risk from cybercrime is significant. Cybercrime threats evolve rapidly and consequently the risk is regularly re-assessed and the Board receives regular updates from the Manager in respect of the type and possible scale of cyberattacks. The Manager’s technology team has developed a number of initiatives and controls in order to provide enhanced mitigating protection to this ever increasing threat. The risk is frequently re-assessed by Fidelity International’s (“Fidelity”) information security teams and has resulted in the implementation of new tools and processes, including improvements to existing ones. Fidelity has established a dedicated cybersecurity team which provides regular awareness updates and best practice guidance. Risks are increased due to the Russia/Ukraine conflict and the trend to more working from home. These primarily relate to phishing, remote access threats, extortion and denial-of-services attacks. The Manager has dedicated detect and respond resources specifically to monitor the cyber threats associated with the change in workplace cyber activity following Russia’s invasion of Ukraine. There are a number of mitigating actions in place including, control strengthening, geo-blocking, and phishing mitigants, combined with enhanced resilience and recovery options. The Company’s third party service providers also have similar measures in place. |
| Investment Performance Risk (including the use of derivatives and gearing) | The achievement of the Company’s investment performance objective relative to the market requires the taking of risk such as investment strategy, asset allocation and stock selection, and may lead to NAV and share price underperformance compared to the Benchmark Index and/ or peer group companies. The Board relies on the Portfolio Managers’ skills and judgement to make investment decisions based on research and analysis of individual stocks and sectors. The Board reviews the performance of the asset value of the portfolio against the Company’s Benchmark Index and its competitors, and also considers the outlook for the market with the Portfolio Managers at each Board meeting. The emphasis is on long term investment performance as there is a risk for the Company of volatility of performance in the shorter term. The Company’s assets consist mainly of listed securities. The Portfolio Managers’ success or failure to protect and increase the Company’s assets against this background is core to the Company’s continued success. Derivative instruments are used to protect and enhance investment returns. There is a risk that the use of derivatives may lead to higher volatility in the NAV and the share price than might otherwise be the case. The Board has put in place policies and limits to control the Company’s use of derivatives and exposures. These are monitored on a daily basis by the Manager’s Compliance team and regular reports are provided to the Board. Further details on derivative instruments risk is included in Note 17 to the Financial Statements below. The Company gears through the use of long CFDs which provide greater flexibility and are currently cheaper than bank loans. The principal risk is that the Portfolio Managers fail to use gearing effectively, resulting in a failure to outperform in a rising market or to underperform in a falling market. The Board regularly considers the level of gearing and gearing risk and sets limits within which the Manager must operate. |
| Environmental, Social and Governance (“ESG”) Risk | There is a risk that the value of the assets of the Company are negatively impacted by ESG related risks, including climate change risk. ESG risks include investor expectations and how the Company is positioned from a marketing perspective and whether it is compliant with its ESG disclosure requirements. Fidelity has embedded ESG factors in its investment decision- making process. ESG integration is carried out at the fundamental research analyst level within its investment teams, primarily through Fidelity’s Proprietary Sustainability Rating which is designed to generate a forward-looking and holistic assessment of a company’s ESG risks and opportunities based on sector-specific key performance indicators across 127 individual and unique sub-sectors. The Portfolio Managers are also active in analysing the effects of ESG when making investment decisions. The Board continues to monitor developments in this area and reviews the positioning of the portfolio considering ESG factors. ESG ratings and carbon emissions of the companies within the Company’s portfolio compared to the MSCI Europe ex UK Index are provided in the Annual Report. Further detail on ESG considerations in the investment process and sustainable investing is in the Annual Report. |
| Key Person and Operational Support Risks | The Portfolio Manager’s style is intrinsically linked with the Company’s investment philosophy and strategy and, therefore, the Company has a key person dependency on him. Fidelity has succession plans in place for its portfolio managers which have been discussed with the Board and provides some assurance in this regard. There is a Co-Portfolio Manager who works alongside the Portfolio Manager and has extensive experience in European markets and companies and shares a common investment approach and complementary investment experience with the Portfolio Manager. This helps strengthen the investment process by introducing greater challenge and also increases the ability to be able to meet more companies. There is also a risk that the Manager has inadequate succession plans for other key operational individuals. The loss of the Portfolio Manager or key individuals could lead to potential performance, operational or regulatory issues. The Manager identifies key dependencies which are then addressed through succession plans, particularly for portfolio managers |
| Operational Resilience Risk | Investment team key activities, including portfolio managers, analysts and trading/support functions, are performing well despite the operational challenges posed when working from home during the pandemic, and more recently, from the rail strikes. With variants of COVID continuing to evolve, it is evident that although the pandemic is being tackled by vaccines, risks remain, especially on how long the effectiveness of vaccines last. There continues to be increased focus from financial services regulators around the world on the contingency plans of regulated financial firms. The risks following Russia’s invasion into Ukraine, specifically regarding the potential loss of power and or broadband services, are increasingly stable as work transfer recovery options are established for business-critical activities. The Manager carries on reviewing its business continuity plans and operational resilience strategies on an ongoing basis. The Manager continues to take all reasonable steps in meeting its regulatory obligations and to assess operational risks, the ability to continue operating and the steps it needs to take to serve and support its clients, including the Board. There have not been any significant changes to Fidelity’s control environment as a result of the pandemic and the rail strikes and the Manager has provided the Board with assurance that the Company has appropriate business continuity plans and the provision of services has continued to be supplied without interruption. Specific risks posed by the pandemic continue to ease with increasing levels of staff returning to routine office-based working, albeit under hybrid working arrangements which allow greater flexibility on remote working as part of the new operating model. The Company’s other third party service providers, principally the Registrar, Custodian and Depositary, have also confirmed the implementation of similar measures to ensure no business disruption and that they continue to manage their operational resilience risk and have appropriate business continuity plans in place. The Registrar, Custodian and Depositary are all subject to a risk-based program of internal audits by the Manager. In addition, service providers’ own internal control reports are received by the Board on an annual basis and any concerns raised are investigated. Risks associated with these services are generally rated as low, although the financial consequences could be serious, including reputational damage to the Company. |
Other risks facing the Company include:
Tax and Regulatory Risks
There is a risk of the Company not complying with tax and regulatory requirements.
A breach of Section 1158 of the Corporation Tax Act 2010 could lead to a loss of investment trust status, resulting in the Company being subject to tax on capital gains.
There is a risk that outstanding withholding tax reclaims may not be recoverable from some jurisdictions and may need to be written-off. The Manager’s tax team works closely with the Custodian to keep these under review and the Board is kept updated on the recoverability of the withholding tax reclaims at each Audit Committee meeting.
The Board monitors tax and regulatory changes at each Board meeting and through active engagement with regulators and trade bodies by the Manager.
Continuation Vote
A continuation vote takes place every two years. There is a risk that shareholders do not vote in favour of the continuation of the Company during periods when performance of the Company’s NAV and share price is poor. At the AGM held on 11 May 2021, 99.99% of shareholders voted in favour of the continuation of the Company. The next continuation vote will take place at this year’s AGM on 10 May 2023 and the Directors expect the vote to be passed.
Viability Statement
In accordance with provision 31 of the 2018 UK Corporate Governance Code, the Directors have assessed the prospects of the Company over a longer period than the twelve month period required by the “Going Concern” basis. The Company is an investment trust with the objective of achieving long term growth in both capital and income. The Board considers long term to be at least five years, and accordingly, the Directors believe that five years is an appropriate investment horizon to assess the viability of the Company, although the life of the Company is not intended to be limited to this or any other period.
In making an assessment on the viability of the Company, the Board has considered the following:
· The ongoing relevance of the investment objective in prevailing market conditions;
· The Company’s level of gearing;
· The Company’s NAV and share price performance;
· The principal and emerging risks and uncertainties facing the Company and their potential impact as set out above;
· The future demand for the Company’s shares;
· The Company’s share price discount to the NAV;
· The liquidity of the Company’s portfolio;
· The level of income generated by the Company; and
· Future income and expenditure forecasts.
The Company’s performance for the five year reporting period to 31 December 2022 was well ahead of the Benchmark Index, with a NAV total return of 53.4% and a share price total return of 61.2% compared to the Benchmark Index total return of 29.4%. The Board regularly reviews the investment policy and considers whether it remains appropriate. The Board has concluded that there is a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the next five years based on the following considerations:
· The Investment Manager’s compliance with the Company’s investment objective and policy, its investment strategy and asset allocation;
· The fact that the portfolio mainly comprises readily realisable securities which can be sold to meet funding requirements if necessary;
· The Board’s discount management policy; and
· The ongoing processes for monitoring operating costs and income which are considered to be reasonable in comparison to the Company’s total assets.
In preparing the Financial Statements, the Directors have considered the impact of climate change, particularly in the context of the climate change risk identified within the ESG Risk above. The Board has also considered the impact of regulatory changes and the uncertainty heightened by the ongoing Russia and Ukraine conflict, and how this may affect the Company.
In addition, the Directors’ assessment of the Company’s ability to operate in the foreseeable future is included in the Going Concern Statement which is below. The Company is also subject to a continuation vote at this year’s AGM on 10 May 2023 and the Board expect that shareholders will vote in favour of continuation.
Going Concern Statement
The Directors have considered the Company’s investment objective, risk management policies, liquidity risk, credit risk, capital management policies and procedures, the nature of its portfolio and its expenditure and cash flow projections. The Directors, having considered the liquidity of the Company’s portfolio of investments (being mainly securities which are readily realisable) and the projected income and expenditure, are satisfied that the Company is financially sound and has adequate resources to meet all of its liabilities and ongoing expenses and continue in operational existence for the foreseeable future. The Board has therefore concluded that the Company has adequate resources to continue to adopt the going concern basis for the period to 31 March 2024 which is at least twelve months from the date of approval of the Financial Statements. This conclusion also takes into account the Board’s assessment of the ongoing risks from evolving variants of COVID, the war in Ukraine and significant market events, as set out in the Operational Resilience Risk in the Strategic Report above. The prospects of the Company over a period longer than twelve months can be found in the Viability Statement above.
Accordingly, the Financial Statements of the Company have been prepared on a going concern basis.
The Board has also considered the upcoming continuation vote at the AGM on 10 May 2023 and are not aware of any circumstances that would result in the continuation vote not being passed.
PROMOTING THE SUCCESS OF THE COMPANY
Under Section 172(1) of the Companies Act 2006, the Directors of a company must act in a way they consider, in good faith, would be most likely to promote the success of the Company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to the likely consequences of any decision in the long term; the need to foster relationships with the Company’s suppliers, customers and others; the impact of the Company’s operations on the community and the environment; the desirability of the Company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the Company.
As an externally managed Investment Trust, the Company has no employees or physical assets, and a number of the Company’s functions are outsourced to third parties. The key outsourced function is the provision of investment management services by the Manager, but other professional service providers support the Company by providing administration, custodial, banking and audit services. The Board considers the Company’s key stakeholders to be the existing and potential shareholders, the external appointed Manager (FIL Investment Services (UK) Limited) and other third-party professional service providers. The Board considers that the interest of these stakeholders is aligned with the Company’s objective of delivering long term capital growth to investors, in line with the Company’s stated objective and strategy, while providing the highest standards of legal, regulatory and commercial conduct.
The Board, with the Portfolio Managers, sets the overall investment strategy and reviews this at an annual strategy day which is separate from the regular cycle of board meetings. In order to ensure good governance of the Company, the Board has set various limits on the investments in the portfolio, whether in the maximum size of individual holdings, the use of derivatives, the level of gearing and others. These limits and guidelines are regularly monitored and reviewed and are set out in the Annual Report.
The Board places great importance on communication with shareholders. The Annual General Meeting provides the key forum for the Board and the Portfolio Manager to present to the shareholders on the Company’s performance and future plans and the Board encourages all shareholders to attend in person or virtually and raise any questions or concerns. The Chairman and other Board members are available to meet shareholders as appropriate. Shareholders may also communicate with Board members at any time by writing to them at the Company’s registered office at FIL Investments International, Beech Gate, Millfield Lane, Tadworth, Surrey KT20 6RP or via the Company Secretary at the same address or by email at [email protected]. The Portfolio Managers meet with major shareholders, potential investors, stock market analysts, journalists and other commentators throughout the year. These communication opportunities help inform the Board in considering how best to promote the success of the company over the long term.
The Board seeks to engage with the Manager and other service providers and advisers in a constructive and collaborative way, promoting a culture of strong governance, while encouraging open and constructive debate, in order to ensure appropriate and regular challenge and evaluation. This aims to enhance service levels and strengthen relationships with service providers, with a view to ensuring shareholders’ interests are best served, by maintaining the highest standards of commercial conduct while keeping cost levels competitive.
Whilst the Company’s direct operations are limited, the Board recognises the importance of considering the impact of the Company’s investment strategy on the wider community and environment. The Board believes that a proper consideration of Environmental, Social and Governance (“ESG”) issues aligns with the Company’s investment objective to deliver long term growth in both capital and income, and the Board’s review of the Manager includes an assessment of their ESG approach, which is set out in detail in the Annual Report.
In addition to ensuring that the Company’s investment objective was being pursued, key decisions and actions taken by the Directors during the reporting year, and up to the date of this report, have included:
· As part of the Board’s succession plan, the appointment and induction of Milyae Park to the Board as Marion Sear’s successor with effect from 1 January 2022;
· As part of the Board’s succession plan, the decision to appoint Paul Yates as the Senior Independent Director on 10 May 2022 when Marion Sear stepped down from the Board;
· The decision to hold a hybrid AGM in 2022 (and again this year) in order to make the AGM more accessible and improve the shareholder experience;
· The decision to pay an interim dividend of 3.08 pence per share and a final dividend of 4.62 pence per share (a total of 7.70 pence per share), to maintain the Board’s policy to pay progressive dividends in normal circumstances. The Company has paid an increased dividend for 12 years in a row; and
· Authorising the repurchase of 2,285,526 ordinary shares into Treasury during the reporting year when the Company’s discount widened.
Statement of Directors’ Responsibilities
The Directors are responsible for preparing the Annual Report and Financial Statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law, the Directors have elected to prepare the Financial Statements in accordance with UK Generally Accepted Accounting Practice (“UK Accounting Standards” and applicable law), including Financial Reporting Standard FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland (“FRS 102”). Under company law, the Directors must not approve the Financial Statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period.
In preparing these Financial Statements, the Directors are required to:
· Select suitable accounting policies in accordance with Section 10 of FRS 102 and then apply them consistently;
· Make judgements and accounting estimates that are reasonable and prudent;
· Present information, including accounting policies, in a fair and balanced manner that provides relevant, reliable, comparable and understandable information;
· State whether applicable UK Accounting Standards, including FRS 102, have been followed, subject to any material departures disclosed and explained in the Financial Statements; and
· Prepare the Financial Statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy, at any time, the financial position of the Company and enable them to ensure that the Company and the Financial Statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, a Directors’ Report, a Corporate Governance Statement and a Directors’ Remuneration Report which comply with that law and those regulations.
The Directors have delegated the responsibility for the maintenance and integrity of the corporate and financial information included on the Company’s pages of the Manager’s website at www.fidelity.co.uk/europe to the Manager. They have delegated this responsibility to the Manager. Visitors to the website need to be aware that legislation in the UK governing the preparation and dissemination of the Financial Statements may differ from legislation in their own jurisdictions.
The Directors confirm, to the best of their knowledge:
· The Financial Statements, prepared in accordance with UK Generally Accepted Accounting Practice, including FRS 102, give a true and fair view of the assets, liabilities, financial position and loss of the Company;
· The Annual Report, including the Strategic Report, includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties it faces; and
· The Annual Report and Financial Statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Company’s performance, business model and strategy.
The Statement of Directors’ Responsibilities was approved by the Board on 20 March 2023 and signed on its behalf by:
VIVIAN BAZALGETTE
Chairman
Fidelity European Trust PLC (LON:FEV) aims to be the cornerstone long-term investment of choice for those seeking European exposure across market cycles.
