JPMorgan European Discovery Trust plc (LON:JEDT), the FTSE 250 trust investing in European smaller companies, announces its interim results for the six-month period ended 30 September 2023
European small caps underperformed large caps during the period, as small caps are particularly sensitive to ‘risk off’ conditions. The Company was not immune to these conditions and the portfolio underperformed its benchmark. However, the Manager has made important enhancements to the portfolio selection process with improved risk management. There has been improved performance over recent months as the portfolio adjustments begin to pay off.
Financial highlights for the Reporting Period include:
· NAV per Ordinary Share of 434.5 pence (as at 30 September 2023) down 12.8% from 31 March 2023
o European small caps underperformed large caps with the benchmark index, MSCI Europe (ex UK) Small Cap Index, declining 5.7% v large cap MSCI Europe (ex UK) NR Index, which declined 2.0%
· Shareholder total return of -10.7%, better than reported return on NAV of -11.4% with the Company’s discount narrowing from -15.1% to -14.8%
· Interim dividend increased to 2.5 p per share (2022: 1.2p)
o To be paid on 5 February 2024 to shareholders on the register as at 29 December 2023
· 50,000 shares were repurchased over the period and a further 3,384,539 shares have been repurchased since the period end. The share price discount has narrowed to 11.3%, as at time of writing.
Operational highlights for the Reporting Period include:
· Enhancements to the investment process and risk management, with increased exposure to Consumer Discretionary and Financials sectors
o Added Technogym, manufacturer of premium gym equipment, De’Longhi, the leading producer of espresso machines for households and businesses, French reinsurer SCOR and Italian bank, BPER Banca
· Arun Sarwal joined the Board as an independent non-executive director.
o Arun has extensive experience developing technology businesses and working in financial services, across a range of industry segments and was previously CEO of Fund Communication Solutions at Broadridge
Outlook:
· The Company’s performance has improved over recent months as portfolio adjustments begin to pay off
· Combination of low valuations of European small caps and possible worldwide central bank easing should be positive for the Company.
CHAIRMAN’S STATEMENT
Investment Performance
Investment companies have had a well-publicised ‘tough year’, with high inflation and global macro-uncertainty taking its toll on performance across many asset classes. Against this backdrop, the Trust underperformed its benchmark over the six months to end of September 2023. During the half year to 30th September 2023, the Company recorded a total return on net assets of -11.4%, with the Company’s benchmark index, the MSCI Europe (ex UK) Small Cap NR Index, returning -5.7% over the same period. The total return to shareholders was -10.7%, slightly better than the reported return on NAV due moderate narrowing of the discount at which the Company’s shares traded, from -15.1% to -14.8% over the six months.
The Company’s longer-term performance has been mixed. Over the past five years, the total return on net assets was 2.0%, compared the benchmark total return of 20.1%. However, over the past ten years, the total return of 119.8% has been high in absolute terms and close to the benchmark return of 124.7%.
The Investment Managers’ Report that follows provides a review of markets, and more detail on the performance drivers within the portfolio, along with some discussion of the market outlook.
Revenue and Dividends
Gross revenue return for the six months to 30th September 2023 was higher than the corresponding period in 2022, at 12.62 pence per share (2022: 12.32 pence). The Board has decided the interim dividend of 2.5 pence (2022: 1.2 pence) per share which will be paid on 5th February 2024 to shareholders on the register as at 29th December 2023 (the ex-dividend date will be 28th December 2023). The Board will keep this matter under review and take into account the income received and the level of the Company’s revenue reserves when determining the final dividend for the year in 2024.
Discount Management and Share Repurchases
The Board continues to monitor closely the level of the discount and believes that its ability to repurchase shares to minimise the short-term volatility and the absolute level of the discount is of prime importance. A total of 50,000 shares were repurchased in the six months to 30th September 2023. A further 3,384,539 shares have been repurchased since the period end. At the time of writing, the share price discount had narrowed to 11.3%.
The Board
In line with the Board’s succession planning and the retirement of Ashok Gupta at the 2023 Annual General meeting, the Board undertook a search to identify a new Director. Following the successful conclusion of this search, and as announced on 9th May 2023, Arun Sarwal was appointed as an independent non-executive director with effect from the conclusion of the Annual General Meeting 2023. Arun has extensive experience developing technology businesses and working in financial services, across a range of industry segments including commercial & investment banking, and asset and wealth management across the globe. Some of his previous roles include his position as the CEO of Fund Communication Solutions at Broadridge.
Environmental, Social and Governance (‘ESG’)
As highlighted in the 2023 Annual Report, the Board has continued to engage with the Manager on the integration of ESG factors into its investment process. These issues are considered at every stage of the investment decision. The Board shares the Investment Managers’ view of the significance of ESG factors, both when making initial investment decisions and during ongoing engagement with investee companies throughout the period of the investment. For more details, please refer to pages 23 to 26 of the 2023 Annual Report, which can be found on the Company’s website at: www.jpmeuropeandiscovery.co.uk.
TCFD
JPMorgan Asset Management (JPMAM) published its first UK Task Force on Climate-related Financial Disclosures (‘TCFD’) Report for the Company in respect of the year ended 31 December 2022 on 30th June 2023. The report is designed to provide investors with transparency into the portfolio’s climate-related risks and opportunities according to the Financial Conduct Authority (FCA) Environmental, Social and Governance (ESG) Sourcebook and the Task Force on Climate related Financial Disclosures (TCFD) Recommendations. The report is available on the Company’s website under the ESG documents section www.jpmeuropeandiscovery.co.uk.
Outlook
Higher interest rates are beginning to bite and economic activity seems to be slowing, which is likely to put earnings and share prices under pressure as we head into 2024. However, there are reasons to be optimistic; rates are at, or near, their peaks in the major developed economies and may begin to fall next year.
The Manager has made changes to the investment process and has enhanced risk management to protect the portfolio on the downside in volatile markets and better position it to capture the upside. Relative performance has improved in recent months, suggesting that these recent portfolio changes are beginning to pay off. The Board welcomes the Managers’ ongoing efforts to further enhance returns by taking advantage of current low valuations to acquire other interesting hidden gems, at attractive prices.
History shows that while European markets have been through challenging periods, performance has subsequently rebounded strongly as these challenges abate. European small cap companies tend to outperform as the broader market rallies. Looking ahead, any signs that central banks are considering lower interest rates should provide a significant boost to investor confidence and equity markets. If history is any guide, European small caps in general, and your Company in particular, should do even better. On this basis, the Board is optimistic about the Company’s prospects over 2024 and beyond.
Marc van Gelder
Chairman
13th December 2023
INVESTMENT MANAGERS’ REPORT
Review
Investor sentiment remained risk adverse as government bond yields continued to move higher. While inflationary pressures began to ease, concerns around unsustainably large government fiscal deficits grew. European small caps underperformed large caps, as small caps are particularly sensitive to such ‘risk off’ conditions.
The benchmark MSCI Europe (ex UK) Small Cap NR Index fell by 5.7 per cent over the review period versus the large cap MSCI Europe (ex UK) NR Index that fell 2.0 per cent.
Portfolio performance
The portfolio’s NAV declined by 11.4 per cent, underperforming its benchmark by 5.7 percentage points, as the Company’s investment process tends to struggle during periods of high volatility. A detailed overview of the Company’s investment process follows this report.
Contributors to performance included French professional installations company, Spie, due to continued high demand driven by the energy transition towards electrification. Scout24, the leading German real estate digital classifieds platform, contributed due to strong growth even as the real estate market remained under pressure. Dutch engineering services provider, Arcadis, outperformed due to increasing demand driven by climate change, the energy transition, and urbanisation.
Over the period, detractors from performance included Bravida, the Swedish commercial building installation company. Its share price came under pressure as cost inflation depressed margins, even though orders held up well. Melexis, a Belgium provider of semiconductor chips primarily for the automotive end market, underperformed due to concerns that high inventories at their customers could temporarily depress demand. Swedish engineering services provider, AFRY, detracted as weaker demand impacted their utilisation rate which depressed margins.
Portfolio changes
During the year, we have made some important enhancements to our process and risk management in the portfolio, seeking to minimise downside risk during periods of volatility and capture upside risk when volatility reduces. The changes made have led to improved portfolio construction and include an increase in the number of holdings, thereby reducing thematic and sector concentration during periods of global stress.
Among other things, we increased the portfolio’s exposure to the Consumer Discretionary sector. Valuations are attractive, inventory levels are normalising, and there is potential for real wage growth as wage increases feed through and inflation moderates. Falling input costs are a further tailwind to earnings. For instance, we added Technogym, the Italian manufacturer of premium gym equipment, and De’Longhi, a leading producer of espresso machines for households and businesses. We increased the portfolio’s Financials holdings, including via French reinsurer, Scor, as operational momentum began to improve following a business restructuring, and Italian bank, BPER Banca, due to its very attractive valuation and better-than-expected profit growth.
To fund these purchases, we reduced our exposure to construction related industrials, as high bond yields are adversely impacting demand for new construction, and cost inflation is putting pressure on margins. For example, we sold Swiss listed Georg Fischer and Dutch Aalberts. We also sold or reduced companies whose market caps had risen due to outperformance to the point where they were no longer small caps. These sales included D’ieteren, a Belgium holding company focused primarily on automotive related end markets, and Prysmian, an Italian manufacturer of high voltage cables which are vital to support the transition towards renewable energy.
As a result of these changes Consumer Discretionary became the portfolio’s largest sector overweight and Financials became the second largest overweight. Healthcare and Real Estate remained the largest underweights due to a combination of poor momentum and expensive valuations. France and Italy remained the two largest country overweights, while Norway and Switzerland remained the two most significant underweights.
At the end of September 2023, portfolio gearing was 3.8%.
Outlook
The long-anticipated global slowdown appears to have finally arrived, and with it the likelihood that central bank rates have peaked. This makes the near-term outlook for equities very hard to anticipate. On the one hand, company earnings are slowing, on the other, the headwinds created by higher rates are starting to show signs of abating. We suspect that earnings will dominate in the near term, keeping equities under pressure, while expectations of lower interest rates may play an increasingly supportive role next year.
Top-down macroeconomic uncertainty has been dominating the performance of stock markets for some time. As a result we have transitioned towards a more diversified portfolio comprising companies that are benefitting from the current high interest rate environment, while adding attractively valued companies that should do well as interest rates begin to fall. While this is a difficult balancing act, the Trust’s performance has improved over recent months as portfolio adjustments are beginning to pay off. Looking to next year, the combination of extremely low valuations for European small caps, and possible central bank easing around the world, should be very positive for markets in general and even more so for our asset class.
Francesco Conte
Edward Greaves
Investment Managers
13th December 2023
JPMorgan European Discovery Trust plc (LON:JEDT) is an investment trust company. The Investment Trust JEDT objective is to achieve capital growth from a portfolio of quoted smaller companies in Europe, excluding the United Kingdom.
