JPMorgan European Discovery Trust plc (LON:JEDT), the FTSE 250 investment trust investing in European smaller companies, has announced its annual results for the year ended 31st March 2024.
The outlook for European small cap companies is considerably brighter as the underlying economic and financial conditions improve, along with real wages. There is also further momentum and interest in the sector this year, given the expectation of at least a couple of rate cuts by the European Central Bank. These positive market conditions, along with the important enhancements to the process and risk management that the new portfolio managers are implementing, have had a positive impact on performance, resulting in JEDT outperforming the benchmark.
Financial highlights for the Reporting Period include:
· NAV per Ordinary Share of 520.7 pence (as at 31 March 2024), up 19.8% since 30th September 2023 and 4.5% from 31st March 2023.
· Total return on net assets was 6.8%, outperforming the benchmark index, the MSCI Europe (ex UK) Small Cap Index in GBP, which returned 5.9% over the same period.
· Shareholder total return of 13.0%, better than reported total return on NAV of +6.8% with the Company’s discount narrowing from -15.1% to -10.6%.
· Full year dividend increased to 10.5p per share (2023: 9.0p).
o Final dividend of 8.0p per share to be paid on 2nd August 2024 to shareholders on the register as at 28th June 2024
· During the year, the Company repurchased 9,782,472 shares at an average discount of 11.8%.
Operational highlights for the Reporting Period include:
· Enhancements to investment process and risk management, seeking to minimise downside risk during periods of volatility and capture upside risk when volatility reduces.
o Resulted in a positive impact on performance, with the net asset value total return outperforming the benchmark.
· Jon Ingram, Jack Featherby and Jules Bloch appointed as named portfolio managers of the Company with effect from 1st March 2024 following internal review of the portfolio management team and its investment process.
· James Will to be appointed as an independent non-executive director with effect from the conclusion of the 2024 AGM.
· Nicholas Smith is to retire from the Board, with the Board’s sincere thanks for his contribution, having served as a Director since 2015.
Tender Offer:
· Following a period of encouraging performance and after consultation with a number of the Company’s largest shareholders, the Board has decided to undertake a tender offer for up to 15% of the issued share capital (excluding shares held in Treasury) of the Company.
· The Tender Offer, which is subject to shareholder approval, will be made at a tender price equal to a 2% discount to the prevailing net asset value per share as at the calculation date, less the costs of implementing the Tender Offer.
· In addition, the Board intends to introduce a performance related tender offer for up to 15% of the issued share capital (excluding shares held in Treasury) of the Company, should the Company’s NAV total return not equal or exceed the benchmark total return over a five year period, ending 31st March 2029.
Outlook:
· Outlook for European small cap companies is considerably brighter than six months ago as economic and financial conditions have improved, and real wage increases should give the recovery further momentum.
· It seems very likely that the European Central Bank will cut interest rates at least a couple of times this year which will further improve economic conditions in the region.
· These positive developments have already had a favourable impact on investor sentiment.
· European small and mid-cap companies tend to outperform as the broader market rallies and based on history, the Company’s carefully selected, high quality, investments should do even better in such markets.
· Looking further ahead, nimble businesses that germinate in the small cap and mid cap space are positioned to benefit significantly from the emerging trends we are seeing, such as the Artificial Intelligence (AI) and research in certain areas in pharmaceuticals.
· The new portfolio management team and the ongoing support of JPMorgan’s extensive research resources position the Company to benefit from this supportive environment and deliver strong results to shareholders over the rest of 2024 and beyond.
CHAIRMAN’S STATEMENT
Investment Performance
Over the year to 31st March 2024 (FY24) the total return on net assets was 6.8%, outperforming the Company’s benchmark index, the MSCI Europe (ex UK) Small Cap Index, which returned 5.9% over the same period. The total return to shareholders was 13.0%, as a result of a significant narrowing of the discount at which the Company’s shares trade relative to NAV, from 15.1% to 10.6% over the year.
The explanation for this performance is in the Portfolio Managers’ report which can be found in the full Annual Report available on the website of the Company. This also provides a detailed commentary on portfolio positioning and the investment outlook.
Whilst the past year’s performance is pleasing, the Company adopts a long-term investment strategy, so it is important to also consider performance over a longer timeframe. On this basis, the Company has underperformed the market over three and five years, returning 3.0% and 41.0% respectively over these periods, compared to benchmark returns of 6.4% and 46.7%, although its longer-term performance remains strong in both absolute and relative terms. Over the ten years to the end of March 2024, its total return on net assets was 121.0%, ahead of the benchmark total return of 115.2%.
Enhancements and Change
The Board has been very mindful of this mixed long-term performance. As I reported in the interim results, over the five years to 30th September 2023 the net asset value total return was 2.0%, compared to the benchmark total return of 20.1%. This followed a period of underperformance in the six months to 30th September 2023 of -11.4% with the Company’s benchmark returning -5.7%. The Portfolio Managers noted in their report that the Company’s investment process tended to struggle during periods of high volatility. During the year, they therefore implemented some important enhancements to their process and risk management, seeking to minimise downside risk during periods of volatility and capture upside risk when volatility reduces.
I am pleased to be able to report that these changes have had a positive impact on performance, with the net asset value total return up 6.8% for the year to 31st March 2024, outperforming the benchmark total return of 5.9%. A significant amount of performance came in the last six months of the financial year, with the net asset value total return up 20.5% against the benchmark return of 12.4%.
As announced earlier this year, in light of the Company’s longer-term performance, the Board of Directors and J.P. Morgan Asset Management (‘JPMAM’) undertook an internal review of the portfolio management team and its investment process. This led to Jon Ingram, Jack Featherby and Jules Bloch being appointed as named Portfolio Managers of the Company with effect from 1st March 2024, replacing Francesco Conte and Edward Greaves. The Board is delighted to welcome Jon, Jack and Jules and looks forward to working with the new investment team to deliver strong, long-term returns for all shareholders. Since 1st March, the new Portfolio Managers have continued to refine the investment process; the changes they have made are set out in their Report
Francesco Conte is retiring and the Board and I would like to take this opportunity to recognise his immense contribution to the Company for over the 25 years since he has been at the helm. Since 1998 the fund has provided a share price total return of some 1,666% through several market cycles and shocks. We would like to thank him for his commitment and efforts during this period, as well as to Edward Greaves who has been a named Portfolio Manager since 2016.
Gearing
Gearing can be a differentiator for an investment trust, and the Board believes that it can be beneficial to performance. The Board sets the overall strategic gearing policy and guidelines, and reviews these at each Board meeting. During the year, the revolving credit facility with Scotia Bank (EUR125m) expired. This facility was renewed for a further two-year term. During the year gearing varied between 10.0% geared and 0.5% cash. At the end of the financial year, gearing stood at 7.9%.
Revenue and Dividends
The Board’s dividend policy is to pay out the majority of revenue available each year to its shareholders. This is set against the Company’s objective of maximising capital growth, and the Portfolio Managers are therefore not constrained to deliver income in any one financial year.
An interim dividend of 2.5 pence per share was paid on 5th February 2024, higher than the previous year’s interim dividend of 1.2 pence, reflecting the increased income received by the Company during the first six months of the financial year, compared to the previous year. After taking into account the income received and the level of the Company’s revenue reserves, and subject to shareholder approval at the forthcoming Annual General Meeting, a final dividend of 8.0 pence per share will be paid on 2nd August 2024 to shareholders on the register as at the close of business on 28th June 2024 (ex-dividend date 27th June 2024). This will take the total dividend for the year to 10.5 pence, compared to a total dividend of 9.0 pence for the previous year.
Discounts and Share Repurchases
The Company’s share price discount relative to net asset value narrowed during the Company’s financial year, from 15.1% as at the end of March 2023 to 10.6% as at 31st March 2024. The average discount over the period was 13.0%. As at 14th June 2024, the discount was 10.76%. The Board continues to monitor the level of the discount carefully and seeks to use its ability to repurchase shares to minimise the short-term volatility and the absolute level of the discount when appropriate.
During the year, the Company repurchased 9,782,472 shares at an average discount of 11.8%.
Manager Evaluation
During the year, the Management Engagement Committee undertook a formal review of the Manager, facilitated by an independent board evaluation firm. The review covered the investment management, company secretarial, administrative and marketing services provided to the Company. The review took account of the Manager’s investment performance record, management processes, investment style, resources and risk control mechanisms. Apart from the changes in the Portfolio Management team as described above, the Board agreed with the Committee’s recommendation that the continued appointment of the Manager was in the best interests of shareholders.
The Board
Nicholas Smith will be retiring from the Board at the end of the forthcoming Annual General Meeting (‘AGM’), having served as a Director since 2015. The Board would like to thank Nicholas for his significant contribution to the Company during his tenure as Audit Chair and Senior Independent Director and wish him well for the future.
Sarah Watters took over the role of the Senior Independent Director of the Company during the year and Arun Sarwal will succeed Nicholas as Audit Chair following the AGM.
In anticipation of Nicholas’s impending retirement, the Board initiated a search earlier this year to identify a new Director. As announced on 13th June 2024, James Will has been appointed as an independent non-executive director with effect from the conclusion of the 2024 AGM. James has extensive investment company experience and my fellow Board members and I look forward to working with him.
Environmental, Social and Governance (‘ESG’)
The Board shares the Investment Manager’s view of the significance of financially material environmental, social and governance (‘ESG’) factors when making long term investments. The Portfolio Managers regularly discuss financially material ESG issues with the management teams of potential and current investee companies on an ongoing basis. Further information on the Manager’s ESG process and engagement is set out in the ESG Report in the full Annual Report.
Shareholder Engagement
The Board believes that shareholder interactions are very helpful in assisting it with the management of the Company’s affairs. Over the course of the year, we have engaged with a number of our largest shareholders to listen to their thoughts and views. The Board values the feedback it has received and insights it has gained through the engagement process and we thank the shareholders for their support.
We remain committed to continued engagement over the coming year; in particular, Board members welcome and seek such meetings as and when such opportunities arise.
During the year, the Board also undertook an Asset Reunification Programme, conducted by the Company’s registrar, which ultimately traced and reunited shareholders with unclaimed shares and dividends in the Company valued at approximately £230,000.
Tender Offer
Following a consultation with a number of the Company’s largest shareholders, the Board has decided to undertake a tender offer for up to 15% of the issued share capital (excluding shares held in Treasury) of the Company (the ‘Tender Offer’). The Tender Offer, which is subject to shareholder approval, will be made at a tender price equal to a 2% discount to the prevailing net asset value per share as at the calculation date, less the costs of implementing the Tender Offer.
In addition, the Board intends to introduce a performance related tender offer for up to 15% of the issued share capital (excluding shares held in Treasury) of the Company (the ‘Conditional Tender Offer’). If the Company’s net asset value total return does not equal or exceed the benchmark total return (MSCI Europe ex UK Small Cap Index (net)) over the five-year period beginning 1st April 2024 and ending on 31st March 2029. The Conditional Tender Offer will be held as soon as practicable following the conclusion of the 2029 Annual General Meeting. The Conditional Tender Offer, which is subject to shareholder approval, will be made at a tender price equal to a 2% discount to the prevailing net asset value per share as at the calculation date, less the costs of implementing the Conditional Tender Offer.
Further announcements in relation to the Tender Offer and Conditional Tender Offer will be made following the conclusion of the Company’s upcoming Annual General Meeting.
Annual General Meeting
The Company’s Annual General Meeting will be held on Wednesday, 24th July 2024 at 12.30 p.m. at 60 Victoria Embankment, London EC4Y 0JP.
The Portfolio Managers’ will give a presentation to shareholders, reviewing the past year and commenting on the outlook for the current year. The meeting will be followed by lunch, providing shareholders with the opportunity to meet the Directors and representatives of the Manager. We look forward to seeing as many shareholders as possible at the AGM.
For shareholders wishing to follow the AGM proceedings but choosing not to attend in person, we will be able to welcome you through conferencing software. Details on how to register, together with access details, will be available shortly on the Company’s website: www.jpmorganeuropeandiscovery.co.uk, or by contacting the Company Secretary at [email protected].
As is normal practice, all voting on the resolutions will be conducted by a poll. Due to technological reasons, shareholders viewing the meeting via conferencing software will not be able to vote on the poll and we therefore encourage all shareholders, and particularly those who cannot attend in person, to exercise their votes in advance of the meeting by completing and submitting their form of proxy.
If you have any detailed or technical questions, it would be helpful if you could raise them in advance with the Company Secretary at 60 Victoria Embankment, London EC4Y 0JP or via the ‘Ask a Question’ link on the Company’s website. Shareholders who are unable to attend the AGM are encouraged to use their proxy votes.
If there are any changes to the arrangements for the Annual General Meeting, the Company will update shareholders through the Company’s website and, if appropriate, through an announcement on the London Stock Exchange.
Stay Informed
The Company delivers email updates with regular news and views, as well as the latest performance. If you have not already signed up to receive these communications and you wish to do so, you can opt in via https://web.gim.jpmorgan.com/emea_investment_trust_subscription/welcome?targetFund=JEDT
Outlook
The outlook for European small cap companies seems considerably brighter than when I wrote my last statement to shareholders for the Half Year Report six months ago. Since then, economic and financial conditions have improved, and real wage increases should give the recovery further momentum. It seems very likely that the European Central Bank (‘ECB’) will cut interest rates at least a couple of times this year which will further improve economic conditions in the region.
These positive developments have already had a favourable impact on investor sentiment. European small and mid-cap companies tend to outperform as the broader market rallies and based on history your Company’s carefully selected, high quality, investments should do even better in such markets. Looking further ahead, as you will read in the Portfolio Managers’ report, the innovative, nimble businesses that germinate in the small cap and mid cap space are positioned to benefit significantly from the emerging trends we are seeing, such as the Artificial Intelligence (AI) and research in certain areas in pharmaceuticals.
These macro and structural developments all bode well for the sector and your Company. Together with a new investment team and the ongoing support of JPMorgan’s extensive research resources, the Board is confident that the Company is well positioned to make the most of this supportive environment to deliver strong results to shareholders over the rest of 2024 and beyond.
Marc van Gelder
Chairman
INVESTMENT MANAGERS’ REPORT
This year was a major one for JPMorgan European Discovery Trust Improved annual results and outlook as the decision was made in February to transition the investment management team to a new team consisting of Jon Ingram, Jack Featherby and Jules Bloch – three experienced portfolio managers with a collective history of 40 years of investing in European Small Caps.
Through this time, especially following a period of tough absolute and relative performance, we appreciate the continued support of all our shareholders. We believe that the change in management team, alongside the continued commitment to the existing investment process, should be positive for our shareholders. As we, the new managers, step in, we would like to thank both Francesco Conte and Edward Greaves for their many years of stewardship and we wish them well going forward.
As to the Company, we are very excited about the current investment opportunity in European Small Caps. It is an asset class with a fantastic long-term track record. As we write in our outlook below, we firmly believe that the current set up of the asset class, one supported by multiple tailwinds, align the Company in a good position to deliver strong returns for you, our shareholders.
Review
The financial year ended 31st March 2024 was marked by dramatic shifts in investor sentiment and market performance. At the start of the period, global markets were still reverberating from the collapse of Silicon Valley Bank (SVB) and Credit Suisse in March 2023.
As concerns around a banking crisis receded, markets were swayed by inflation figures and the corresponding reactions of central banks. As the year progressed, investors welcomed confirmation that inflation rates were falling. Nonetheless, central banks continued to raise rates, motivated by concerns that inflation would otherwise become entrenched.
There was almost universal consensus amongst forecasters that Europe was heading into recession, induced by the compounding effects of a regional energy crisis, Russia’s invasion of Ukraine, double-digit inflation and monetary tightening that pushed interest rates to their highest level in well over a decade.
This recession failed to materialise, but these macroeconomic fears still had a significant impact on European Small Cap stocks which are typically more levered to the economic performance of their national home markets.
Inflation rates around the world cooled as the year progressed, and central bankers started to recognise the progress made on the inflation front. In late October 2023, Federal Reserve Chairman Powell adopted a more dovish stance, marking a significant turning point in investor sentiment. Global equity markets began a recovery that continued through to the end of the review period.
Though European smaller companies did benefit from the improvement in market sentiment in the second half of 2023, they have now underperformed European large companies by more than 25% since September 2021. This is the longest and sharpest period of underperformance in the past 20 years. These periods have historically been followed by strong outperformance of European smaller companies.
Table 1: Periods of European Small Cap underperformance and the corresponding performance rebound
| Under- | 5Y forward | ||
| Period | Number of months | performance | outperformance |
| September 2021 – March 2024 | 30 | -29% | Still within period |
| March 2007 – December 2008 | 22 | -15% | 95% |
| March 2018 – September 2019 | 19 | -10% | Still within period |
| January 2011 – December 2011 | 12 | -10% | 53% |
| March 2014 – October 2014 | 8 | -7% | 19% |
Source: J.P. Morgan Asset Management, Bloomberg. Large Caps: MSCI Europe, Small Caps: MSCI Europe Small Caps
Portfolio Performance
Despite the volatility induced by macroeconomic factors, the Net Asset Value of the Company increased by 6.8% during the year, outperforming the benchmark by 0.9%.
Performance attribution
Year ended 31st March 2024
| % | % | |
| Contributions to total returns | ||
| Benchmark return | +5.9% | |
| Asset allocation | -1.6% | |
| Stock selection | 1.5% | |
| Gearing/cash effect | 1.1% | |
| Currency effect | 0.1% | |
| Investment Managers’ added contribution | 1.1% | |
| Portfolio return | 7.0% | |
| Management fees/other expenses | -0.9% | |
| Share Buy-Back | 0.7% | |
| Other effects | -0.2% | |
| Return on net assetsA | 6.8% | |
| Return to shareholdersA | 13.0% |
Source: JPMAM/Morningstar.
All figures are on a total return basis.
Performance attribution analyses how the Company achieved its recorded performance relative to its benchmark.
A Alternative Performance Measure (‘APM’)
A glossary of terms and APMs is provided in the Annual Report.
The relative performance of the Company has been volatile during the year. Performance was adversely impacted in periods where macroeconomic themes dominated. For instance, the portfolio underperformed in the last quarter of 2023, when expectations of significant interest rate cuts fuelled a substantial rally in low-quality and high-risk companies.
However, since the start of 2024, company fundamentals have become the main driver of share price performance again. In the first three months of 2024, the NAV increased 10.4% compared to 2.1% for the MSCI Europe ex-UK Small Cap index.
Sector contribution
Table 2: Sector performance – Top 3 and Bottom 3 sectors contributing to performance
| Account (%) | Benchmark (%) | Attribution (%) | |||||
| Group | Avg Wgt | Return | Avg Wgt | Return | Selection | Allocation | Total |
| Communication | |||||||
| Services | 6.28 | 21.78 | 4.77 | 8.67 | 0.84 | 0.03 | 0.87 |
| Materials | 5.17 | 7.32 | 7.91 | -4.08 | 0.51 | 0.20 | 0.71 |
| Financials | 14.01 | 35.30 | 13.92 | 26.16 | 0.88 | -0.22 | 0.67 |
| Utilities | 0.82 | -4.28 | 2.78 | 3.18 | -0.25 | -0.04 | -0.29 |
| Consumer | |||||||
| Discretionary | 17.42 | 0.23 | 8.22 | 0.41 | -0.03 | -0.76 | -0.79 |
| Information | |||||||
| Technology | 12.70 | -13.25 | 10.48 | -6.29 | -1.30 | -0.01 | -1.31 |
Source: J.P. Morgan Asset Management
Our overweight to Communication Services contributed positively to performance during the year. Our large overweight in CTS Eventim, the German online ticketing platform, delivered strong performance; the cost of live entertainment skyrocketed in 2023 due to increased demand as consumers returned to the experiences they missed out on during the pandemic. Ticketing platforms benefitted from this ‘revenge spending’ which shows no sign of abating.
The positive attribution from Materials is the result of our underweight to companies that have been hurt by energy prices, have structurally low returns on invested capital or were delivering earnings that we thought were not maintainable. Our focus on defensive companies with strong balance sheets and high cash flow conversion allowed us to outperform the sector. This includes the German producer of industrial lubricants Fuchs Petrolub, which has a robust medium-term volume growth potential because of recent capacity investments, while the deflation in base oils is a tailwind to its margins and cash flows.
Despite the volatility induced by the collapse of SVB and Credit Suisse at the start of the period, the Financial sector was one of the largest contributors to returns at the sectoral level. After it became clear that these bank failures were isolated events, this undervalued sector stabilised and reaped the benefits from high interest rates and low bankruptcy rates. Our investment in BPER Banca, the Italian banking group, performed particularly strongly for these reasons.
The largest sectoral detractor from performance was the portfolio’s stock selection in Information Technology. Our exposure to automotive semiconductor companies such as Melexis and Elmos suffered from the sharp slowdown in the electric vehicle market and fears of a broad-based destocking from automotive OEMs. Our overweight to IT consulting companies such as Alten, Reply and Tietoevry also contributed negatively as clients postponed some IT and innovation projects due to macroeconomic uncertainty.
The portfolio’s overweight to Consumer Discretionary also contributed negatively. Elevated rates of inflation and increasing interest rates eroded consumer confidence in 2023. Our overweight to auto suppliers such as Forvia and Plastic Omnium contributed negatively as they were hit by significant cost inflation, leaving their levered balance sheets under pressure. Other companies related to construction such as JM (a Swedish housing developer) or Ariston (an Italian manufacturer of heating solutions) also suffered from the impact of tightening monetary policies.
Stock contribution
Table 3: Investment performance – Top 3 and Bottom 3 investments contributing to performance
| Account (%) | Benchmark (%) | |||||
| Security Name | Avg Wgt | Return | Avg Wgt | Return | Wgt Diff | Total Effect |
| Top 3 Contributors | ||||||
| SPIE | 3.45 | 30.07 | 0.49 | 29.28 | 2.96 | 0.71 |
| Arcadis | 2.18 | 48.14 | 0.39 | 48.56 | 1.78 | 0.57 |
| CTS Eventim | 2.49 | 41.69 | 0.47 | 41.46 | 2.02 | 0.56 |
| Bottom 3 Contributors | ||||||
| Bravida | 2.26 | -21.71 | 0.20 | -22.25 | 2.06 | -0.85 |
| Melexis | 1.90 | -28.42 | 0.21 | -29.25 | 1.69 | -0.78 |
| Forvia | 0.81 | -44.14 | 0.37 | -31.44 | 0.44 | -0.76 |
Source: J.P. Morgan Asset Management
During the year our biggest contributors to performance at the stock level were: SPIE, the French technical services company, as demand for installation of electrical systems was boosted by the ongoing energy transition towards electrification; Arcadis, the Dutch engineering and architecture services company, which has benefitted from strong infrastructure investments in the US and in Europe; and CTS Eventim, as demand for live events continued to grow significantly post-COVID.
The biggest detractors to performance were Bravida, the Swedish multi-technical services company, as the sharp slowdown in Swedish residential construction led to significant pricing pressure for installers; Melexis, the Belgian manufacturer of automotive chips, as automotive manufacturers who over-ordered chips due to post-COVID supply chain constraints now have to reduce their inventories in a slowing demand environment; and Forvia, the French automotive supplier, as the company did not manage to increase prices enough, while increasing interest rates put pressure on a stretched balance sheet.
Portfolio Changes
During the review period, we aimed to position the Company to take best advantage of the opportunities available.
We acquired several Healthcare companies with strong innovation pipelines, thereby increasing our allocation to the Healthcare sector. These included Zealand Pharma, a Danish biotech company with interesting weight-loss assets. We believe the development of anti-obesity drugs has become a key structural driver of the Healthcare sector, and Zealand Pharma offers exposure via its long-acting amylin petrelintide. This drug could have a better tolerability profile than existing weight-loss drugs, and thus offer a superior patient experience. We also purchased Bonesupport, a Swedish biotechnology company with a unique and innovative bone graft technology platform which is perceived as vastly superior to current standards of care, with lower deep infection rates and a higher rate of bone union. Bonesupport’s offering is now approved for various applications, which will allow the company to grow very rapidly.
We also identified several attractive investment opportunities in the Energy sector. After years of underinvestment in energy infrastructure, recent changes in the geopolitical landscape are reshaping energy supply chains. This has been positive for European companies in the sector, which still trade at attractive valuations. One such company is Vallourec, a French producer of premium pipes for oil & gas drilling and distribution. In the past 18 months, a new management team has cut debt, closed loss-making operations across Europe, and re-focused commercial efforts on high-margin applications. As a result, Vallourec is now a profitable and cash-flow generative business, trading at an appealing valuation. We also purchased GTT, a French engineering company specialising in the design of cryogenic membrane containment systems for liquid natural gas (LNG) shipping and storage. LNG’s share of the world’s energy consumption is increasing as the world strives to cut its dependence on energy sources with higher carbon emissions. The war in Ukraine has accelerated investments in liquefaction and LNG transportation, which materially improved GTT’s growth prospects.
Real Estate is the other area to which we increased exposure. With inflation under control, and interest rates set to decline, we expect real estate companies with strong balance sheets to start trading closer to the net asset value (NAV) of their underlying assets. We purchased TAG Immobilien, a German residential company. TAG’s stock trades at a significant discount to NAV despite a low-risk leverage ratio, high occupancy rates, increasing rents and an attractive growth pipeline in the Polish market. We also bought Merlin Properties, which owns diversified real estate assets in Spain. Merlin has a strong balance sheet and will use its financial firepower to invest in data centres, which are expected to see sustained demand from the rapidly rising appetite for data processing and storage. We expect this growth to be value accretive for Merlin, but the stock still trades at a significant discount to the portfolio’s NAV.
To fund these purchases, we reduced overweights to IT and Industrials. Within the Technology sector, we adopted a more cautious stance on automotive semiconductors. In the post-pandemic recovery, automotive component companies struggled to source chips due to supply chain disruptions. This benefited chip manufacturers, as availability became more important than price. However, automotive component makers now have adequate levels of chip inventories and demand for electric vehicles is slowing. The earnings growth prospects for automotive chip manufacturers are therefore less attractive and we have reduced exposure accordingly. We sold Elmos Semiconductors and Melexis due to their deteriorating operating momentum.
Within Industrials, we reduced our exposure to companies with high exposure to construction; activity in the sector has suffered due to the rapid rise in interest rates. Building permits in Germany are down almost 50% from the peak levels of 2021. During the year, we sold industrial companies such as Georg Fischer (which produces piping systems), Ariston (a supplier of heating systems), Aalberts (which makes flow control devices) and AFRY (an architectural services company). Other names in the Industrial sector such as Prysmian, Trelleborg and d’Ieteren were sold because they left our investment universe following strong performance.
Despite the disposal of these companies, Industrials remain the portfolio’s most significant overweight. Any recovery in manufacturing activity would provide a tailwind for many of the industrial companies we own, but our holdings have company-specific drivers that should help them perform regardless of the economic environment. Do&Co for example is an Austrian airline catering company taking market share from struggling peers thanks to its unique ‘premium fresh cuisine’ branding. An economic slowdown is unlikely to slow the pace at which the company opens new locations and signs new airlines. Another holding, Bilfinger, is a German industrial services company whose new management is implementing better risk controls and pricing mechanisms, which should significantly increase their operating margin. Although an improvement in economic conditions would help, the stock’s performance will depend mainly on these internal reforms.
The same is true for our overweight to Consumer Discretionary. Consumer confidence, growth in real disposable income and the unemployment rate are all significant drivers of consumer spending. With inflation and energy prices falling, consumer sentiment in Europe has rebounded from the lows of September 2022. This should help the businesses we own in the sector, but their strong brands and exposure to structurally growing categories are more significant drivers of stock performance. For example, De’Longhi, an Italian manufacturer of home appliances, has built a solid reputation for ‘premium quality at the press of a button’ coffee machines, allowing it to benefit from the significant growth in global coffee consumption. Sanlorenzo’s tailor-made and exclusive superyachts are recognised for their exceptional Italian design, which makes them appealing to a growing population of ultra-high-net-worth individuals.
Materials continues to be the portfolio’s largest sectoral underweight. Many companies in the sector are commoditised, capital intensive, cyclical businesses, with a poor track record of shareholder value creation. Strong post-pandemic demand and the sharp increase in energy prices after the invasion of Ukraine significantly boosted the price of materials. However, the subsequent rapid fall in gas and electricity prices will at some point turn into a headwind for earnings in the sector. During the year we sold our position in Verallia, the French glassmaker. The shortage of glass in 2022 and early 2023 gave glassmakers exceptional pricing power. We doubt these earnings will be maintainable.
Despite some sectoral over and underweights, our sector allocation is balanced relative to benchmark, as every sector is offering attractive investment propositions. Investors’ focus on macroeconomic variables and their implications for monetary policy has led to a raft of valuation dislocations. Not only are small cap valuations extremely attractive compared to history, but we think the opportunity set for alpha creation through stock-picking is also wider than usual.
Our ability to use gearing to increase market exposure has the potential to further enhance returns in a rising market. Gearing stood at 7.9% at the end March 2024 and has since remained stable.
Outlook
Because of the attractive valuations European smaller companies currently trade at, we think the expected return for the asset class is higher than usual. In addition, the macroeconomic headwinds the asset class faced over recent years are now fading. The market expects the ECB to cut interest rates during 2024 and this should boost investor sentiment, thereby benefitting small cap companies.
Furthermore, the latest data points suggest that global and European economies are more resilient than anticipated. Indicators such as Purchasing Managers’ Index (‘PMI’) appeared to have bottomed. And for the first time in years, major European economies are seeing growth in real wages, which should continue to improve consumer confidence.
The asset class should receive further support from the resurgence of mergers and acquisitions (M&A) activity. There has been a lull in deal flow within the European Small Caps space in recent years, but attractive valuations and the prospect of lower rates could drive a marked pick-up in M&A activity.
Small cap companies are also likely to be supported over the longer-term by emerging themes such as Artificial Intelligence (AI) and drug-assisted weight loss. To date, both these themes have mostly played out in the mega cap space. However, the main point for small cap investors is that most of tomorrow’s winners might be today’s small caps. For example, Amazon and ASML were small caps back in 2000, while Tesla and Meta were not even founded.
It is our strong conviction that many of the companies which will be most successful in capitalising on the AI revolution, pharmaceutical breakthroughs and other emergent structural trends over the coming years are yet to be identified, or even conceived, and are thus most likely to emerge from the small cap space.
We expect this confluence of attractive valuations, favourable macroeconomic trends, and long-term thematic developments to act as key drivers for small caps, which have outperformed every asset class globally over the past 25 years.
All this leaves us feeling positive about the prospects for the portfolio. In fact, in our view, the outlook has rarely been brighter, and we expect our shareholders to benefit accordingly.
Jon Ingram
Jack Featherby
Jules Bloch
Investment Managers
PRINCIPAL AND EMERGING RISKS
The Directors confirm that they conduct a robust assessment of the principal and emerging risks facing the Company. It is with a focus on those risks that could materially adversely impact the Company’s performance, share price, reputation or the viability of its business. The reviews are based on a risk matrix developed by the Audit Committee with the assistance of the Manager.
During the year, the Board discussed the risks and identified those that merit particular attention. At the current time these are – investment performance, discount control and the impact of geopolitical events. At the same time, they viewed that the threat of a recession and the adverse impact of further pandemics as having declined over the year.
The AIC Code of Corporate Governance requires the Audit Committee to put in place procedures to identify emerging risks facing the Company. The Committee has conducted horizon scanning and other than the exacerbation of geopolitical events in Ukraine & the Middle East, growing usage of Artificial Intelligence and continuing Climate Change, it does not believe that there are any new emerging risks.
The risks together with how these are mitigated and managed, as far as practicable, are set out in the table below.
| RISK & DESCRIPTION | MITIGATION & MANAGEMENT |
| Investment Performance and StrategyPerformance of the Company’s investment portfolio is fundamental to the success of the company.An inappropriate investment strategy, or poor implementation of the strategy, for example relating to concentration of investments, asset allocation, the level of gearing or the degree of portfolio risk. | Ongoing performance measurement of the portfolio computed independently of the investment managers. This is shared within Investment Managers teams for ongoing oversight as well as to the Board.The Board reviews the overall strategy and structure of the Company and reports of comparison of the performance against benchmark, peer group and share activity. The Board holds a separate meeting devoted to strategy each year which includes consideration of whether the Company’s objectives and structures are appropriate for the long-term interests of shareholders.Regular reports prepared by the Manager are received by the Board on stock selection, asset allocation, gearing, hedging and costs of running the Company and these are reviewed at each Board meeting. |
| Discount/Premium ControlShare price premium volatility and deep discount to net asset value per share leads to a sense of uncertainty reducing shareholder confidence. Potentially triggering shareholder intervention. | The Board continuously monitors the level of the discount. Where deemed it prudent, seeks to address the imbalances in the supply of and demand for the Company’s shares through share repurchases. |
| GeopoliticalMarket instability and declining investment opportunities from escalation of geopolitical conflicts such as in Ukraine and the | The Company monitors global developments with the Manager and external experts on an ongoing basis.The Board can, with shareholder approval, amend the investment policy and objectives of the Company to mitigate the risks arising from geopolitical instability. |
| Market and CurrencyUncertainty about the future prices and liquidity of the Company’s investments arising from economic, social, fiscal, climate, inflationary and regulatory changes. This covers the impact of holding investments in the face of negative market movements.The company has an inherent risk exposure to the Euro/Sterling exchange rate. The majority of the Company’s assets, liabilities and income are denominated in Euros, rather than in Sterling which is the Company’s functional currency and in which it reports performance. | The Board manages these risks by diversification of investments and monitoring compliance with investment guidelines and policies with the Investment Manager.The Board includes an assessment of these risk factors at meetings and has placed investment restrictions and guidelines to limit these risks. The Board also reviews the level of liquidity in the portfolio.The Company borrows in Euros in order to hedge the currency risk in respect of the geared portion of the portfolio. The Company does not hedge the foreign currency exposure of the remainder of the portfolio. |
| Loss of Key PersonnelLoss of one or more of the investment management team, particularly key individuals. | The Manager ensures appropriate performance reviews and benchmarked incentivisation and compensation. In addition, ongoing succession planning through a team-based approach.The Board also takes a keen interest in getting to know the individuals through attendance at Board meetings and their participation at the off-site Strategy meetings. |
| Shareholder RelationsFailure to communicate effectively and regularly and appropriately with the different shareholder constituencies. | The Manager has a programme of visiting major institutional holders and providing presentations via various platforms to communicate more widely with its investors. Extensive range of investor information and nation-wide presentations are done by the Sales teams and feedback via brokers is reviewed for improvements.In addition, the Board arranges regular meetings with major institutional holders and responds to questions and matters raised at AGMs or in the interim by shareholders. |
| Operational and Cyber CrimeIn common with most investment trusts the Board delegates the operation of the business to third parties, the principal delegate being the Manager.Disruption to, failure of, or fraud in the Manager’s accounting, dealing or payments systems or at its service providers (Custodian, Depositary or Registrar) preventing timely implementation of investment decisions, and potentially shortfalls in the accuracy of reporting and monitoring of the Company’s financial position.Cyber-attack impacting business continuity, breaches of information security and integrity of data. | The Audit Committee receives independently audited reports on the Managers and other service providers’ internal controls, as well as a report from the Manager’s Compliance function.The Company’s management agreement obliges the Manager to report on the detection of fraud relating to the Company’s investments and the Company is afforded protection through its various contracts with suppliers, of which one of the key protections is the Depositary’s indemnification for loss or misappropriation of the Company’s assets held in custody.Details of how the Board monitors the services provided by JPMF and its associates and the key elements designed to provide effective risk management and internal control are included within the Risk Management and Internal Control section of the Corporate Governance Statement in the Annual Report.The Board Is kept up to date with the Manager’s cyber security defences and its cyber security programme. The information technology controls around the physical security of data centres, security of its networks and trading applications are tested and reported on every. |
| Accounting, Legal and RegulatoryFailure to comply with existing and emerging accounting, fiscal regulatory rules. The Company operates in an environment with significant regulation including the FCA Listing Rules, The UK Companies Act, the Corporation Taxes Act, Market Abuse Regulation, Disclosure Guidance and Transparency Regulations and the Alternative Investment Fund Managers Directive (AIFMD).An example is the breach of Section 1158 which would lead to a loss of investment trust status and, as a consequence, gains within the Company’s portfolio would be subject to capital gains tax. | The Board relies on the services of its Company Secretary, the Manager (JPMF) and its service providers and professional advisers to ensure compliance. Relying on relevant processes reviewed on a regular basis including by Internal Audit and Risk & Operational audits together with regular consultation with External Auditors and meetings of the Audit Committee.Specifically, the Section 1158 compliance is continually monitored by the Manager and the results reported to the Board each month. |
| Artificial Intelligence (AI)AI has become a powerful tool that will impact a huge range of areas. It could be a significant driver for new business as well as a disrupter to current business models and processes leading to emerging uncertainty in corporate valuations. There is also an increased potential risk from cyber related crime. | The Manager’s investment process integrates financially material considerations of the impact of AI when taking investment decisions.The Board works with the Manager to monitor the developments concerning AI and its potential impact on the portfolio, our service providers and the wider market. |
| Climate ChangeClimate change has an increasingly significant impact on the business models, sustainability and even viability of individual companies, sectors and asset classes, impacting investment performance and valuations in the short and longer term. | The Manager’s investment process integrates financially material considerations of environmental, social and governance (ESG) factors when taking investment decisions. This includes considering the approach investee companies take to recognising and mitigating climate change risks.This is outlined in Investment Manager’s Report.The Board reviews ESG reports from the Manager on the way ESG considerations are integrated into the investment decision making.It also considers, where relevant, the direct impact on climate change from the nature of operations of the Manager and other service providers. At the level of the Company, as extreme weather events become more common, the resiliency, business continuity planning and location strategies of the Company’s service providers will come under greater scrutiny. |
TRANSACTIONS WITH THE MANAGER AND RELATED PARTIES
Details of the management contract are set out in the Directors’ Report in the Annual Report. The management fee payable to the Manager for the year was £5,773,000 (2023: £6,416,000), of which £nil (2023: £nil) was outstanding at the year end.
Included in administration expenses in note 6 in the Annual Report are safe custody fees payable to JPMorgan Chase amounting to £79,000 (2023: £86,000) excluding VAT of which £8,000 (2023: £30,000) was outstanding at the year end.
The Manager may carry out some of its dealing transactions through group subsidiaries. These transactions are carried out at arm’s length. The commission payable to JPMorgan Securities Limited for the year was £44,000 (2023: £67,000) of which £nil (2023: £nil) was outstanding at the year end.
The Company also holds cash in JPMorgan Euro Liquidity Fund, which is managed by JPMF. At the year end, this was valued at £7.2 million (2023: £46.6 million). Interest amounting to £683,000 were payable (2023: £nil) during the year of which £53,000 (2023: £nil) was outstanding at the year end.
Securities lending income amounting to £131,000 (2023: £113,000) were receivable by the Company during the year. JPMAM commissions in respect of such transactions amounted to £15,000 (2023: £13,000).
Handling charges on dealing transactions amounting to £49,000 (2023: £59,000) were payable to JPMorgan Chase during the year of which £17,000 (2023: £29,000) was outstanding at the year end.
At the year end, the Company held cash of £311,000 and an overdraft of £394,000, resulting in net overdrawn amount of £83,000 (2022: cash held of £445,000 and £nil overdraft) with JPMorgan Chase Bank N.A. A net amount of interest of £118,000 (2023: £2,000) was receivable by the Company during the year from JPMorgan Chase of which £nil (2023: £1,000) was outstanding at the year end.
Full details of Directors’ remuneration and shareholdings can be found in the Annual Report.
STATEMENT OF DIRECTORS’ RESPONSIBILITIES
The Directors are responsible for preparing the Annual Report and Accounts 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 United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under company law the Directors must not approve the financial statements unless they are satisfied that, taken as a whole, the Annual Report and Accounts are fair, balanced and understandable, provide the information necessary for shareholders to assess the Company’s position and performance, business model and strategy and that they give a true and fair view of the state of affairs of the Company and of the total return or loss of the Company for that period. In order to provide these confirmations, and in preparing these financial statements, the Directors are required to:
• select suitable accounting policies and then apply them consistently;
• make judgements and accounting estimates that are reasonable and prudent;
• state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and
• prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business
and the Directors confirm that they have done so.
The Directors are responsible for keeping proper 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 to enable them to ensure that 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.
The financial statements are published on the www.jpmeuropeandiscovery.co.uk website, which is maintained by the Company’s Manager. The maintenance and integrity of the website maintained by the Manager is, so far as it relates to the Company, the responsibility of the Manager. The work carried out by the Auditors does not involve consideration of the maintenance and integrity of this website and, accordingly, the Auditors accept no responsibility for any changes that have occurred to the financial statements since they were initially presented on the website. The financial statements are prepared in accordance with UK legislation, which may differ from legislation in other jurisdictions.
Under applicable law and regulations the Directors are also responsible for preparing a Directors’ Report, Strategic Report, Statement of Corporate Governance and Directors’ Remuneration Report that comply with that law and those regulations.
Each Director, whose names and functions are listed in the Annual Report confirm that, to the best of their knowledge:
• the financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and return or loss of the Company; and
• 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 that it faces.
The Board confirms that it is satisfied that 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 strategy and business model of the Company.
For and on behalf of the Board
Marc Van Gelder
Chairman
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.
