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European small caps bask in the sun of recovery

European small caps bask in the sun of recovery

There never appears to be a good time to invest in European small companies, but now might be a better time than any says Ollie Beckett, who is relishing a 62% one-year total return from the TR European Growth (TRG) investment trust he manages.

With Brexit in the UK and Donald Trump in the US making the two investment go-to regions unstable, investors had looked to Europe for returns. ‘The big turning point was [French presidential candidate] Marine Le Pen not goose-stepping away with the presidency. People were worried,’ said Beckett.

However, he had been less concerned than investors in the US and UK and said he was ‘buying into France going into the election because it looked cheap, because of the fear factor’.

There is general consensus that Europe has stabilised after falling far behind the recoveries in the UK and US post-financial crisis. Since 2007, corporate earnings growth in the US has been 74%, in the UK it has been 67% but the eurozone has managed just 6% growth.

While Beckett (pictured) said Europe had been slow to recover, partly because of the different types of companies it had. While the US was home to tech companies and the UK to service companies, ‘Europe is a bit grungy, dirty, and industrial’, he said.

‘It also competes with Asia and for the last 10 to 15 years Asia, particularly China, has been exporting deflation,’ said Beckett.

‘European companies have not seen their profit margin go up and now we see they are almost exporting inflation. What we have seen this year is southern Europe recover - GDP growth is over 3% in Spain, and Italy and France are moving in the right direction.’

The real story in Europe, Beckett argued, was small companies, which were forecast to grow earnings per share this year at 17.8%, compared with 14.2% for UK large companies, 13.1% for European large caps and 12.3% for UK small caps.

‘It’s never the time to invest in European small caps but maybe it is now,’ he said.

‘European small cap is a great play on global growth,’ he added.

He said the biggest downside for Europe was a slowdown in the US economy but he was not concerned that Europe could falter. ‘Europe hasn’t been in recovery for that long...it’s not inevitable that the recovery will end very soon,’ he said.

Shares in the £684 million trust currently trade just 0.5% below net asset value (NAV), having narrowed from a peak discount of 25% two years ago. According to the manager this proved the appetite for European small caps had returned.

‘I’m a big believer that long-run small caps is the place to be,’ he said. ‘These are the growth companies of tomorrow. The large caps, if you look back over time, are paying income but they’ve not grown enough.’

Beckett's aim is to invest in ‘undervalued companies where the perception the market has of them is wrong’, including buying into bad companies that can be turned around, such as French cable company Nexans.

‘We met them and said ‘you’re a terrible company, what are you going to do about it’,’ he said. ‘They said they would cut costs and close plants. It went from being a bad company to being an OK company and that is where we can make money.’

However, Beckett added he was not an activist investor and does not claim to know more than management about an industry but he does ‘know key drivers for what may move the shares’.

One company Beckett has sold out of is UK-based Dialogue Semiconductors, which provides power management for iPhones.
‘The more stuff Apple put in iPhones, the more power you need. I sold it because it depends on Apple and I’m aware of what happened with Imagination, and Apple do not treat suppliers in the best way. Apple is also building its own power management team in Munich.’

Although Dialogue has more content in the iPhone than before, Beckett said he did ‘not want to come in one day and see Apple isn’t using them now when I knew that Apple was building their own team in Munich’.

‘The company may do well in the meantime and it may diversify its customer base, but it’s about risk-reward,’ said Beckett.

One holding the manager would like to offload is Brainlab, an unquoted company that develops guided surgery technology.
‘We value it at a discount because we have had it for 17 years and it is not liquid,’ he said.

‘The problem is the majority of the shares are held by the founder who does not want to give seats on the board.’

One area that Beckett did sell out of is Spain, where he is underweight, although he maintains he did not see the problems with Catalonia coming.

‘We are underweight Spain not because we foresaw the last couple of weeks but because we could not find interesting companies,’ he said.

‘We did sell a Catalan insurance company which was fortuitous, but we sold it because it was expensive, not because it was based in Barcelona.’

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