Henderson European Focus Trust (HEFT)

08/12/2022

Results analysis from Kepler Trust Intelligence

For the financial year ending 30/09/2022, Henderson European Focus Trust (HEFT) reported a NAV total return of -13.1% and a share price return of -18.3%, underperforming the -12.8% return of its benchmark, the FTSE World Europe ex UK Index.  Noticeably, HEFT's returns were significantly better than the AIC Europe sector average of -19.3%.

The managers' more valuation-conscious approach helped them during the year versus the growth-oriented peer group, with holdings in the energy sector in particular contributing to performance. However, versus the benchmark the consumer exposure was unhelpful while the unexpected Russian invasion of Ukraine also hurt returns.

At the start of the financial year, the board took advantage of low interest rates and locked in cheap long-term borrowing. In two tranches of loan notes, EUR35m was borrowed for 25 and 30 years at a weighted average interest rate of just 1.57 %. This provides structural gearing of 9.7% of year-end NAV on a gross basis which, in addition to the flexible borrowings in place, affords the fund managers the flexibility to make full use of gearing as opportunities present themselves.

Kepler View

It has been a challenging period for equity investors as economies struggle with the impact of rocketing inflation and an exceptionally fast increase in US interest rates. Henderson European Focus Trust's (HEFT) flexible, valuation-conscious approach has helped the trust do better than the peer group average in NAV total return terms, but the returns have nonetheless been disappointing on an absolute basis, and marginally behind those of the benchmark. Looking forward, we think HEFT looks like an interesting way to invest in a beaten-up European equity market and play a potential recovery. First, the managers' flexible approach means they can take advantage of mis-pricings across the market - sentiment is so poor towards equities that we think there are likely to be opportunities in good companies swept up in the negativity in multiple industries. Secondly, the very cheap long-term gearing affords maximum flexibility to take advantage of any eventual market recovery.

Tom O'Hara and John Bennett argue that Europe is "exceptionally cheap in pockets". In particular, they argue that the market has not yet acknowledged we have seen a macroeconomic regime shift. They believe that inflation is likely to remain higher than pre-pandemic levels for a long time, even after the current spike has declined. In their view the market has not priced this in, which leads to opportunities in "quality, cash generative champions across energy, materials and industrials, with strong management teams and, most importantly, pricing power." In recent months, the managers have been adding to existing positions which possess these qualities, taking advantage of share price weakness. Examples include chemicals company Arkem, which was added to on a multiple of less than 6 times enterprise value to earnings before interest, tax and depreciation (EV/EBITDA). Meanwhile construction and materials producer Holcim was added to on less than 7 times EV/EBITDA and industrial tool manufacturer Atlas Copco was added to after a 30% YTD decline. Though these companies have some cyclical sensitivity, Tom and John believe that they will be relative winners and will deliver strong returns to shareholders. Accordingly, they are explicit about their appetite to increase the trust's gearing into the expected recovery, utilising the low-cost loan notes placed earlier in 2022.

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