Buy the recovery with European Assets Trust

IC TIP RATING

Tip style: INCOME

Risk rating: HIGH

Timescale: LONG TERM

The euro, meanwhile, has fallen in response to ECB action to meet its inflation target, which should also be a benefit to small and mid-sized companies, particularly those that export.

General valuations of European shares have moved up, but due to where we are in the economic cycle - early stage recovery - they do not look as expensive, explains Ms Haugaard. Meanwhile, the valuation gap between smaller and larger European companies has contracted significantly so it is less than usual, meaning smaller companies look relatively cheap.

"The small-cap universe in Europe is large and diverse with around 2,500 companies," says Ms Haugaard. "Active managers benefit from high levels of inefficiency in the market as the sell side community give significantly less coverage and attention, compared to large- and mid-caps. In addition, small-cap investment offers higher rates of growth, greater mergers and acquisitions opportunity, and size and liquidity premiums."

A good way to access European smaller companies is IC Top 100 Fund European Assets Trust (EAT). This investment trust has performed strongly, significantly beating its benchmark, Euromoney Smaller European Companies (ex UK) Index and the other investment trusts in the Association of Investment Companies (AIC) European Smaller Companies sector, over one, three and five years.

The trust also offers a very attractive yield of 5.4 per cent, which it pays out of both dividends from the companies it invests in and capital. Its policy is to pay an annual dividend equivalent to 6 per cent of its net asset value (NAV) at the end of the preceding year, unless circumstances prevent this.

Ms Haugaard highlights the fact that although the trust picks its holdings according to the individual attributes of the underlying companies, its largest exposure is Germany - which should particularly benefit from a weakening euro because there are a number of exporters there. Around a third of the sector exposure is consumer focused and these should benefit from the economic recovery and lower oil prices.

The trust's managers look to find value and combine fundamental analysis, with scrutiny of balance sheets and cash flows. They believe the most important factors that influence stock returns are the value creation of the business and the initial price paid to own the equity.

The trust also has a relatively low portfolio turnover rate of 24 per cent, and less frequent trading means costs eat less into the returns.

Markets could correct in the short term if investors think they are over bought, while the trust trades close to par. A weak euro is also less beneficial for UK investors who have to translate returns back to sterling.

However, the trust has generally traded around par for the past three years, and its rating is much less than some trusts offering a similar yield. Buying euro assets while the pound is strong could be a good move, especially as the pound might weaken around and after the election in May.

So if you are a long-term investor with a higher risk appetite that can tolerate some volatility, a holding in European Assets Trust and exposure to European small- and mid-cap companies could mean you benefit from recovering growth. Buy.

Source: Morningstar, *F&C

Performance

Source: Morningstar as at 27 March 2015

TOP 10 HOLDINGS as at 28 February 2015 (%)

Geographic breakdown (%)