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European Opportunities Trust offers investors access to a high conviction portfolio of European equities with a bias towards medium and larger companies. Formerly known as the Jupiter European Opportunities Trust, it was renamed at its annual general meeting in November 2019. This change in name coincided with its appointment of Alexander Darwall’s new investment management company, Devon Equity Management, as its new investment manager.
Alexander has developed a consistent investment process that has a record of success in different economic environments. Here, he talks to us about the current uncertainties in the market and how he thinks investors should approach European equities in this climate.
“European markets are still, despite the setback this year, ahead of where they were before the onset of the covid pandemic,” Alexander pointed out.
“In addition to the obvious challenges presented by covid-related developments and policies, the conflict in Ukraine and surging inflation have added to investor concerns. Yet quantitative easing (QE) has carried all before it, inflating asset prices.
“Not only is this asset inflation likely to spill over into ‘real’ inflation but it is likely to push central bankers into winding down their QE programme and start raising interest rates. This, in turn, is likely to cause slower economic growth and a squeeze on profits.
“Indeed, the latest growth forecasts for Europe for 2022 have been downgraded to within a range of 2.2% to 3.6% (previously 3.3% to 4.6%) with the concomitant impact on corporate earnings growth.”
“We approach this prospect with a mixture of caution, patience, and confidence,” said Alexander.
“One element of our caution concerns debt. Why? Because the prospect of higher interest rates is a serious threat to companies carrying too much debt. Slower economic growth is also likely to dampen consumer spending.
“So, we seek to identify companies with less debt than most, higher levels of profitability and strong cash flow.
“Our emphasis is also on B2B (companies that sell to other companies), as opposed to B2C (companies selling to consumers). Of course, B2B is not without risk, but there are chances to mitigate risk by picking companies’ whose products and services have demonstrable value, and where it is possible to monetise that value by selling to a rational, business customer base.
“We also think that we can more easily monitor the ability of business customers to pay than retail consumers. In the event of a squeeze on household incomes, we think that pockets of B2B will remain more resilient. Our caution as regards debt is reflected in the level of gearing in the European Opportunities Trust. Current gearing of 8.1%, is lower than has been the case historically.
“The turnover of the fund is relatively low,” continued Alexander. “We seek to identify strong, secular winners and then exercise a good deal of patience. This has paid off and there are many examples in the portfolio where our perseverance has delivered good results – Novo Nordisk, for example.
“We eschewed the temptation of taking profits too soon, recognising that its new class of therapeutic drugs for diabetes and obesity underpins a significant expansion in the business. Even now, we are in the early phases of this expansion, and we believe that it is right to stay patient and stick with the company.
“At a macro level, it is a mistake to think that visibility is ever good, but seldom have there been so many uncertainties in the outlook. Our intention is that the portfolio is proofed for many different economic scenarios. That being the case, we remain patient where we have successfully identified ‘special’ companies that can flourish in a range of economic scenarios. Chopping and changing in response to every economic development is often a losing strategy.
“Notwithstanding the multiple challenges facing European equity markets, we are very confident that there are good winners to be found,” Alexander said. “There are always winners and losers from tremendous changes: digital, and other technologies; changing consumer habits; and changing regulatory requirements in addition to the obvious upheaval from the energy transition and new political disruption.
“We seek to identify ‘special’ companies, companies which are structural winners, companies that have strong, durable advantages which competition finds hard to erode, and which regulators are unwilling to erode.
“Again, taking the example of Novo Nordisk, we believe that the company enjoys sustainable advantages with its differentiated technologies. There are relatively few companies capable of competing with the broad range of technological, logistical, and reputational advantages that Novo Nordisk enjoys. Innovation is the crucial factor in its development; very few can rival its capabilities.
“We find these ‘special’ companies in many different areas of business. Indeed, our portfolio is very well diversified in terms of activities. Our investments include winners, we believe, from digital trends; winners in food and crop sciences; winners in the energy transition; winners in professional services; and winners in pharmaceuticals. We are also well diversified in geographic terms. In the main, this is a portfolio of global winners that happen to be European listed. This is an advantage as the outlook for economic growth in Europe looks likely to continue its long track record of lagging other trading blocs.
“Whilst the macro backdrop is more challenging, there are great investment opportunities,” concluded Alexander. “Whereas QE helped sustain failing business models with very cheap debt, and lifted equity valuations, a slightly harsher macro environment should lead to a starker division between winners and losers.
“We believe that our active management and well-honed strategy should prevail in these circumstances. We stick to the same strategy that has served us well for many years and which we consider to be well suited to the present investment conditions.”