JPMorgan European Smaller Comp: Sentiment Improving

Strong year so far, ready for next phase
JPMorgan European Smaller Companies Trust, (JESC.L) invests in small-cap Continental European equities. Within the portfolio there are four investment themes: secular growth, quality financials, cyclically sensitive stocks and restructuring plays. A combination of screening and stock picking based on fundamental research and the managers’ substantial combined experience have allowed the trust to outperform its benchmark over one, three, five and 10 years, to the end of August.

Investment strategy: Awaiting next trend
JESC invests in small-cap Continental European equities, primarily in the €100m-2.5bn range. The two fund managers, Jim Campbell and Francesco Conte, have worked together for over 15 years and apply their knowledge and judgement aided by a proprietary screening tool developed by JPMorgan Asset Management. Although the portfolio is not constrained in terms of sector or country exposure, the NAV correlation with the fund benchmark has been relatively high and the tracking error low so, based on past performance, the fund provides reasonably representative exposure to the European small-cap universe. The managers have been increasing the cyclical exposure of the portfolio, but have recently reduced gearing from 15% to 3%, waiting for new market trends to emerge before re-gearing.

Sector outlook: Sentiment improving
While European economic growth remains lacklustre, the European equity market and small-cap stocks within it have enjoyed a strong period (the trust’s benchmark is up 27% year to date). Nevertheless, valuation metrics do not appear obviously stretched compared with long-term averages or the world average. There has also been a definite improvement in collected sentiment surveys in Europe, pointing to the potential for a gradual improvement in the economic background. This raises the possibility of further expansion of multiples and eventual positive earnings surprises. JESC seeks high quality stocks and has a broadly neutral sensitivity to market movements, with a beta close to 1.0, allowing investors to benefit from such an improving scenario through an actively managed portfolio.

Valuation: Narrower discount warranted
The current ex-income discount of 10.5% is below the three-year average of c 15%. Improved sentiment towards Europe and the trust’s performance have probably acted as catalysts and underpin the move.

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