Fund Spotlight: outperformer benefits from investment trust structure

The investment trust universe has been under pressure due to myriad factors. Those factors include investors’ shift from active management to index products, higher financing costs and prolonged selling of UK-listed companies. The current landscape is marked by deep discounts for many trusts and a raft of M&A activity and wind-downs, as well as high-profile activist campaigns such as by Elliott and Saba Capital.

This may have led some to question the utility of a trust over a fund or exchange-traded fund (ETF) in mainstream asset classes. So, it is a good time to remember where trusts can offer value. For example, holding illiquid assets (e.g. small-caps or real assets) without concerns over redemption, being able to enhance returns via borrowing, or withholding dividends for future payouts.

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The European Smaller Companies Trust (LSE:ESCT) is a successful, well-managed trust that has overcome many of the aforementioned challenges. Despite a record of outperformance, ESCT was targeted by Saba’s campaignlate last year and early this year due partly to its persistent discount. Briefly put, while Saba’s attempt to replace directors and management was rejected, a resolution was ultimately achieved to enact a tender offer for 42.5% of shares, allowing investors (including Saba) to exit.

More recently, ESCT and Columbia Threadneedle’s smaller European Assets (LSE:EAT)agreed to a combination (subject to shareholder approval). This will see ESCT’s scale return to nearly £800 million, while EAT’s assets will be selectively absorbed and its shareholders may take up new ESCT shares, or a limited cash exit option.

The benefits to EAT’s shareholders are most apparent. They can roll into the larger, better performing and less-discounted ESCT, though both trusts will benefit from enhanced fee arrangements and scale. However, the synergies are not absolute and EAT’s investors will be joining a very different strategy. The trusts are stylistically different, with ESCT more biased to small-cap versus EAT’s mid-cap profile, and EAT investors are accustomed to a sizable dividend yield (typically of over 5%), meaning a change of dividend policy for the enlarged ESCT.

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What does it invest in?

ESCT looks to grow capital by investing in small and mid-caps listed, domiciled or operating within Europe (ex UK), and is managed by Ollie Beckett (since 2011), alongside Rory Stokes and Julia Scheufler. Management believe the smaller end of the market has greater scope for mispricing, while also housing growth opportunities that may be tomorrow’s winners. Accordingly, there’s a bias to true small-caps versus its European Smaller Companies trust peers and the MSCI Europe ex UK Smaller Companies benchmark, which is more biased to mid-cap.

The process looks for businesses offering future growth, but where fundamental value is overlooked, which can mean investing in neglected or unloved segments of the market. The team invest modestly across early-stage companies (6% of the portfolio), but the bulk is within more established quality-growth (45%) and mature companies (33%), as well as companies potentially due a turnaround (27%).

Beckett is a believer in diversifying at a stock level, with c.120 holdings and 21% of assets in the top 10. In terms of sector composition, the trust is concentrated in the Industrials sector (36%). Top holdings include the Dutch TKH Group (a provider of automation, digitisation and electrification solutions) and German KSB (a producer of pumps and valve systems – interestingly including for nuclear power plants). Technology (12.8%) and Consumer Services (11.2%) form the next largest allocations.

Geographically, there’s meaningful differentiation from benchmark. The team look through the headlines of poor economic news emanating from Germany where they actually find the greatest number of opportunities, comprising 23.1% of the portfolio (13.1% of benchmark). Meanwhile, the allocations to Sweden and Switzerland of 12.9% and 8.8% (the benchmark’s largest country weightings) are underweight.

Another important factor is that the trust can apply leverage (up to 30%), and has typically done so dynamically. Going into the year, gearing stood at around 14% of net assets, though has been reduced to nil by June.

How has the fund performed?

While ESCT has typically taken more risk than the benchmark, it has paid off, given the trust outperforms benchmark in price terms over one, three, five, 10 years and beyond. Admittedly, price returns have been flattered by a narrowing discount, accelerating through 2024 – beginning the year at 14% and ending at 6% - supported by Saba Capital building an interest of 28% of share capital (a position no longer held). Nonetheless, net asset value (NAV) returns are also strong for ESCT over the long term.

Through the first half of 2025, ESCT’s strong NAV return of 24%, (more than 6% above its benchmark) was supported by stellar returns for Industrials names within the defence space such as Renk Group – a provider of military mobility solutions and anticipating to benefit greatly from increased NATO spend requirements, and Exosense - a producer of night vision hardware.

Investors should be aware that the portfolio is very cyclically positioned, leaving performance rather exposed to the macroeconomic environment, which given last year’s raft of European elections with some unexpected results and the US Administration’s aggressive trade policy towards the EU, is anything but stable. However, this is a long-held overweight for the trust, with Beckett seeing reasons to be positive towards European economies going forwards, such as the Christian Democratic Union’s ambitions to revive Germany’s economy, the spillover of Chinese stimulus measures and a low base of valuations.

Source: Morningstar Market Returns (GBP). Past performance is not a guide to future performance.

Why do we recommend this investment trust?

ESCT is well-managed with a consistent record of outperformance over Beckett’s tenure and the trust’s lifetime. Given its propensity to invest in true small-caps and even early-stage companies, the investment trust is a logical vehicle for avoiding the liquidity pitfalls with doing so.

The rollover of EAT into ESCT (assuming approval) should bring greater scale and lower fees (down to 0.5% a year on the first £800 million of assets with no change to performance fees), with Beckett and team continuing to manage the trust and likely minimal transaction costs borne by investors. While there is no intended change to investment policy for ESCT, the new target of a 5% dividend yield, roughly double ESCT’s current level will seemingly be partially funded by revenue and (if required) capital – meaning funded by the sale of portfolio assets - which could be a drag on future growth for the trust.

Overall, though, we view that consolidation of smaller trusts with weaker performance into more sizable, stronger products seems a healthy process of natural selection for the industry, and ESCT has certainly been a best-in-class trust to carry forward and serve the larger investor base.

This fund can be found on ii’s Super 60 list of investment ideas. The latest factsheet can be viewed here.