Ian Cowie: hedging out my US risk

After America’s Federal Reserve raised interest rates for the first time in three years yesterday amid rising anxiety about whether Wall Street’s boom in share prices must end in a bust, it makes sense for investors to diminish risk by diversification.

Bear in mind that most bull markets, or periods of soaring share prices, end when bond yields and interest rates rise faster than expected, making shares look relatively less attractive. 

Whether or not the Bank of England demonstrates its independence of the British government by raising its base rate this month or next, when it is most likely to wait until after the Budget on October 28, rising money costs put funds and shares paying low or no income under threat.

By contrast, Continental European rivals priced on lower valuations, paying higher yields than their Yankee competitors look relatively more attractive. 

Investment trusts are a convenient and cost-effective way to gain exposure to overseas markets while sustaining rising income.

Nor is the cliche about Continental European funds being excessively focused on fashion and luxury goods still true. 

For example, the biggest underlying holding in JPMorgan European Growth & Income Ord (LSE:JEGI), an investment trust with £917 million in assets, is ASML Holding NV (EURONEXT:ASML), the Dutch business that makes machines that make microchips.

Roche Holding AG Bearer Shares (SIX:RO) and Novartis AG Registered Shares (SIX:NOVN), the Swiss healthcare and pharmaceutical giants, are the second and third-largest holdings in JEGI. 

Siemens AG (XETRA:SIE), the German engineer, Nestle SA (SIX:NESN), the Swiss food and drink group, and Banco Santander SA (XMAD:SAN), the Spanish bank, also feature in this fund’s top 10.

It all adds up to total returns over the last decade, five-years and one-year periods of 241%, 98% and 21% respectively. 

As mentioned earlier, it isn’t all about capital growth because there is also rising income. The current dividend yield is 3.8%, with the trust having adopted an enhanced dividend policy after merging its two shares classes in 2022. It seeks to pay out 4% of net asset value (NAV) each year.

Ongoing charges of 0.64% and a 3% discount to NAV are both modest but do little to spoil the view. 

JEGI leads the Association of Investment Companies Europe sector over the last decade and five-year periods but is pipped to the post over the last year by Baillie Gifford European Growth Ord (LSE:BGEU).

Less yield, more growth

As its name suggests, BGEU is less interested in income, currently yielding just under 0.6%.

However, the more volatile nature of its growth-seeking strategy is shown by total returns of 109% over the  decade, a loss of 21% over five years; and a positive 24% last year. BGEU’s biggest asset is Bending Spoons SpA (NASDAQ:BSP), an Italian technology conglomerate that focuses on reducing costs and increasing revenues at existing brands through digital innovation.

ASML and Roche also feature in BGEU’s top 10 assets. Once again, costs look reasonable at 0.66% and the discount to NAV is 7.5%.

Smaller companies on the Continent can also deliver capital growth and rising income. 

The The European Smaller Companies Trust PLC (LSE:ESCT), which absorbed the long-term underperformer European Assets Trust last October, leads its sector over the last decade, five years and one year.

This £950 million fund achieved that impressive hat-trick by delivering total returns of 251%, 48% and 20%. 

These included the current yield of 3.7% after increasing distributions by an annual average of 12% over the last five years.

As might be expected from a portfolio of overseas medium-sized  and smaller companies, none of the underlying assets is a household name in Britain. 

But, as mentioned earlier, it is encouraging to see technology featured in top 10 holdings including Elmos Semiconductor SE (XETRA:ELG), the German microchip-maker. Ongoing charges are 0.68%. Despite all that, ESCT shares continue to be priced 8.3% below their NAV.

JPMorgan European Discovery Ord (LSE:JEDT) ranks second in this sector over the last five years and one-year periods with total returns of 28% and 17%. This £669 million fund yields 2.6% income.

Interesting assets among its top 10 holdings include Glanbia (LSE:GLB), the Irish dairy business that grew into a leader in sports supplements and protein powders. 

JEDT has ongoing charges of 0.88% and trades at an 8.5% discount to NAV.

European funds haven’t featured much in the news or business pages recently. But, depending on how rising bond yields and  interest rates affect equity valuations, there might yet be a time when investors decide that boring is beautiful again.

Ian Cowie is a shareholder in The European Smaller Companies Trust, JPMorgan European Growth & Income and Nestlé as part of a globally diversified portfolio of investment trusts and other shares. You can see more at iancowie.co.uk