European Assets Trust focuses on financials

But profits have not recovered from the crisis and European earnings are significantly below their peak. This means they have the potential for recovery, and economic indicators such as composite European Purchasing Managers' Indices (PMI) are rising, suggesting an improved outlook, he adds.

"If we see any recovery, Europe will look attractive," says Mr Cosh. "Normalised valuation measures that take account of longer-term profit levels are below their long-term average and look attractive for long-term investors. There is potential for much more recovery. Valuations are no longer obviously cheap, but still look attractive on depressed levels of profitability.

"I am not sure that we will see further market re-rating, but we may see profit growth. I think quality businesses will be the ones that can improve earnings - those with high returns on capital that can endure. The easy gains have gone, so it is a case of picking companies that can deliver good profit growth."

He also points out that corporate fundamentals are good and have strengthened through the downturn. This has been reflected in portfolios through improving payouts to shareholders via dividends and share buy-backs. "Companies that have navigated their way through the crisis well have learned to conserve and generate cash," he says. "Corporate Europe has a strong balance sheet and is set to generate significant amounts of cash."

Examples include financial services company IFG Group (IFP), which has a strong balance sheet as a result of a disposal, enabling it to do a substantial share buy-back.

Shipping company Irish Continental sold off part of its international freight business which generated huge amounts of cash, even at the bottom of the cycle.

And Aareal Bank (ARL), a German specialist property lender, has used its balance sheet to acquire assets at massive discounts. "We expect much bigger payouts from this company in the future," says Mr Cosh. "The company's strong management team is focused on efficient use of capital and driving margin improvements, and has demonstrated the ability to achieve both over the course of the recent macroeconomic downturn. As a result, the company is positioned to emerge from the recession in a stronger position than it entered into it."

Mr Cosh is positive on financials, the trust's largest sector exposure, accounting for 27.2 per cent of assets. "This is an area that has seen massive capital retrenchment and destruction, but those that navigated through the crisis are in strong positions now and able to make improving returns," he says. "This is certainly not reflected in their valuations."

Performance has been boosted over the past year by positions taken in more cyclical areas such as financials and automotive stocks. For example, top holding Azimut (AZM), an Italian asset manager, had a share price rise of more than 100 per cent in the 12 months to mid-March, buoyed by inflows as specialist asset managers took market share from troubled Italian banks.

Mr Cosh is not so keen on large-cap auto companies, but likes smaller ones that provide specific parts to help improve engines. Portfolio holdings include Plastic Omnium (POM), which he bought in early 2013. It makes lightweight car components that help reduce overall vehicle weight. Its shares were up 119 per cent over the 12 months to mid-March.

While small- and mid-cap valuations are at a premium to large caps, Mr Cosh argues that this accounts for the growth you get with small caps, especially in a recovery.

He also expects mergers and acquisition (M&A) activity to pick up, which he says should be positive for smaller companies. Company balance sheets are strong and these could be increasingly used for acquisitions, while low funding costs could drive attractive returns on invested capital.

"US companies are also taking steps to buy in Europe, where they can see profits are cheap," he says.

Performance issues

While European Assets Trust has beaten its benchmark, the Euromoney Smaller European Companies (ex UK) Index, over three and five years, it has not done this over one year. This is partly because of its focus on quality shares, which means it has slightly lagged a strongly rising market in recent months.

The trust's managers stated in its annual report: "We would not expect this strategy to necessarily deliver outperformance at all times in the market cycle, and we would expect this to happen when more value and cyclical areas dominate."

Not all of the longer-term performance is attributable to Mr Cosh as he became lead manager in 2011, although he has been a member of asset manager F&C's European team since 2010.

The trust offers a high yield of 5.8 per cent as a result of its policy of paying an annual dividend equal to 6 per cent of its net asset value (NAV) at the end of the preceding year. This should result in a total dividend of €0.699 a share in 2014, up 27 per cent on 2013.

Around a third of this comes from income, and two-thirds from capital. The trust has been able to pay dividends out of capital because it is domiciled in the Netherlands. Paying dividends out of capital is not common among UK-domiciled investment trusts as this was not allowed until 2012, and only a few have so far elected to do this.

Despite its high yield, European Assets is only on a slight premium of 0.69 per cent, and its 12-month average is a discount of 0.63 per cent. The trust has traded at a slight discount or premium since the middle of last year, while a number of investment trusts with attractive yields are on substantial premiums.

Source: Morningstar & *F&C

Performance

Source: Morningstar, as at 13 May 2014

Top 10 holdings as at 31 March 2014

Sector breakdown