Small-cap star survives attack and makes dividend switch

The European Smaller Companies Trust outperformed its benchmark on both a net asset value (NAV) and share price basis in the year to the end of June 2025. The benchmark’s return of 14% was narrowly outpaced by The European Smaller Companies Trust PLC (LSE:ESCT) portfolio’s NAV return of 14.5%, and even more so by the share price return of 21.9%.

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The strong price return was supported by a narrowing of the discount from -11.2% to -5.8%. The trust’s stronger second-half performance stemmed from a marked improvement in Europe’s political and economic climate, renewed investor confidence in European smaller companies, and particularly successful stock selection in German industrials, infrastructure, defence, and financials, all of which benefited from fiscal stimulus, falling rates, and easing inflation.

This financial year has certainly been an eventful one for the trust. Despite a record of outperformance, ESCT was targeted by activist investor Saba’s campaign late 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. The tender offer reduced ESCT’s share capital, aligning the share price closer to NAV and removing the activist pressure.

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ESCT also merged with European Assets, with the combination completing on 15 October.

This brings the company net assets to £811.9 million, making it the largest constituent of the Association of Investment Companies’ (AIC) European Smaller Companies sector. The combined portfolio will be more liquid than ESCT due to more of a mid-cap bias. A reduction in the management fee has also been negotiated which will stand to benefit investors.

Following its merger with European Assets, the company introduced a new quarterly dividend policy. It now aims to pay shareholders a total annual dividend of at least 5% of the previous year’s NAV, funded from income, capital gains, or reserves which results in an almost doubling of the current distribution.

The investment strategy will be 100% unchanged, which raises questions regarding the potential impact on future growth, primarily for those not reinvesting the dividend.

The numbers in detail (for the year to 30 June 2025)

Net Asset Value (NAV) Return: +14.5%
Share Price Return: +21.9%
Benchmark Return (MSCI Europe ex UK Small Cap): +14%
Premium/Discount: -5.8% (vs -11.2% in prior year)
Dividend: 4.9p (vs 4.8p in prior year)
Gearing: 5.8% (vs 10.7% in prior year)

Outlook

Investment manager Ollie Beckett welcomed the renewed optimism around European small caps and pointed to a combination of factors; easing inflation, lower energy costs, and Germany’s fiscal stimulus following the end of its “debt brake”, which have all been headwinds in recent years.

While risks remain from US trade tariffs and the ongoing war in Ukraine, European small caps still trade at attractive valuations. The managers see strong potential in undervalued smaller companies driving technological and structural growth and remain confident in finding mispriced opportunities in this vast opportunity set.

Portfolio

ESCT’s portfolio is primarily defined by bottom-up selection, but typically the focus on valuations and growth potential has led management to favour (or avoid) certain sectors. The trust still allocates most heavily to industrials at 30% of the portfolio and 17% to technology, while being underweight healthcare and utilities. Geographically, Germany remains the largest country allocation at 23% of the portfolio (8% overweight).

While the trust usually invests in Europe excluding the UK, a recent addition made for a rare exception in adding a London-listed holding, IG Group Holdings (LSE:IGG). The core business is online trading for retail and institutional clients across a range of instruments. Management deems the business to be cheap and possessive of great cash-generative capabilities.IG Group’s substantial share buybacks made it one of the trust’s top contributors over the year.

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Other new positions during the year include several Spanish companies, HBX Group International (XMAD:HBX) (consumer discretionary); Indra Sistemas SA SHS Class -A- (XMAD:IDR) (technology); Clinica Baviera SA (XMAD:CBAV) (healthcare); Viscofan SA (XMAD:VIS) (consumer staples); and Neinor Homes SA (XMAD:HOME) (consumer discretionary).

The trust also participated in the IPOs of Enity in Sweden (financials) and Pfisterer in Germany (industrials). Additional German investments included Aixtron SE (XETRA:AIXA), Carl Zeiss Meditec AG (XETRA:AFX), Bilfinger SE (XETRA:GBF), and HomeToGo SE (XETRA:HTG), reflecting increased exposure to technology, industrials, and consumer sectors across Europe.

Discount

During the year, the discount narrowed from -11.2% at the start of the year to -5.8% at the end. The trust managed its discount primarily through a substantial 42.5% tender offer completed in June 2025, rather than ongoing share buybacks, providing a liquidity event for shareholders and helping narrow the discount to NAV.

Gearing

The gearing level throughout the year was 5.8%, falling from around 10.7% in the prior year and moving in line with sector peers.

Dividend

The board has declared a final dividend of 3.45p per share, which was paid to shareholders on 8 October 2025. This brought the total dividend for the year ended 30 June 2025 to 4.90p per share, representing a 2.1% increase on the prior year.

ii View

In the year to end of June 2025, ESCT delivered a healthy NAV return of 14.5% to investors, marginally outperforming against the return of the MSCI Europe ex UK Small Cap benchmark. The optimism around European equity markets since 2025 has boosted the wider market, as has the mild narrowing of the extraordinarily large discount at which European small caps were trading compared with European large-cap and US equity.

The exaggerated share price return of 21.9% is a product of the trust’s discount narrowing. The 10-year average discount for the trust is -10.8%. The current level of -5.8% is now in line with the mid-single digit discount target for the trust.

The year reveals relatively minimal change from a sectoral positioning point of view within the portfolio, as management continue to find the most numerous opportunities in industrials and technology, which together make up near half of the portfolio. Over the past year, returns have come from companies across a broad swathe of sectors and regions.

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German firm Alzchem Group AG Akt. nach Kapitalherabsetzung (XETRA:ACT) benefited from niche leadership in chemicals (creatine and nitroguanidine) and from renewed investor appetite for German industrials and defence-linked names.

R&S Group Holding AG (SIX:RSGN) has received a boost owing to Switzerland being a major beneficiary of Europe’s power-grid modernisation, tied to the green transition and infrastructure renewal.

Southern European banks (Alpha Bank, Optima Bank, Banco Comercial Português, Credito Emiliano (MTA:CE)) and Van Lanschot Kempen NV NLDR (EURONEXT:VLK) (Netherlands) all gained as sentiment towards financials improved alongside rising rates and stronger returns on equity.

While the trust’s remit of investing across small-cap businesses, from quality-growth to neglected market segments and undervalued businesses, can make for high volatility for investors, the experienced team of Ollie Beckett, Rory Stokes and Julia Scheufler, and the stock-selection process have proven themselves over the short and long term with NAV and share price outperformance of the benchmark index over one, three, five and 10 years.

The trust earns its place on ii’s Super 60 list of investment ideas as a small-cap option for investors with a tolerance for volatility and long-term investment horizons.