Buy into quality at depressed valuations via Baillie Gifford European Growth

Baillie Gifford European Growth Trust (BGEU) looks like a promising way to access such investment opportunities. The trust changed the company that manages it from Edinburgh Partners to Baillie Gifford in November last year, since when it has performed very well. Analysts at Investec say that the change in manager has “dramatically reinvigorated the fortunes of the company”, wiping out nearly a decade of material underperformance in just six months.

The trust is now run by Stephen Paice and Moritz Sitte, who have been running open-ended Baillie Gifford European Fund (GB0006058258) since 2011 and 2014, respectively. This fund is ranked first out of 104 Europe ex UK open and closed-ended funds over five years and has returned 272 per cent over 10 years versus 109 per cent for MSCI Europe ex UK index, according to Investec. Analysts at broker Winterflood add that the investment trust is benefiting from replicating the open-ended fund's portfolio, which has been developed over a number of years.

Mr Paice and Mr Sitte run a concentrated portfolio of 30 to 60 companies that they think should deliver superior returns over five to 10 years. They believe that niche European small and mid-cap business-to-business companies, in particular, have strong growth potential. So around half of Baillie Gifford European Growth Trust's assets are in companies with market caps of between €1bn (£890m) and €10bn as they like to own companies from an early stage when their business prospects are strongest. The trust can also invest in smaller companies with a market cap below €500m, which the managers believe increases the number of potential companies they could invest in by about 300 relative to the open-ended fund they run. And they hope to build an allocation to unquoted companies worth up to 10 per cent of the trust's assets in the next three years. 

Another advantage of the investment trust structure is that Mr Paice and Mr Sitte can take on gearing – debt – when they deem it appropriate to invest more than its assets in markets. This can boost returns if what they invest in does well. 

The trust's holdings are exposed to trends that have performed relatively well over the past few months, including digitalisation, industrial consolidation, outsourcing and the shift to online commerce. The trust has a bias to Northern Europe, notably Sweden, in which it had 25 per cent of its assets at the end of April. This is a lot higher than the proportion of FTSE Europe ex UK index Sweden accounts for, which was about 6 per cent at the end of April. The reason for this is because Mr Paice believes some companies listed in this country are among the most innovative and resilient in Europe. The trust also has a very competitive ongoing charge of 0.62 per cent.

European economic growth contracted 3.8 per cent in the first quarter of this year and some analysts predict that a depression is on the horizon for certain industries and sectors. It is also not yet clear what long-term impact the virus will have on European economies and markets.

Baillie Gifford European Growth Trust is also trading at a discount to net asset value (NAV) of over 3 per cent. But this is considerably tighter than the sorts of levels it was trading at prior to Baillie Gifford's appointment as manager when it was, at times, on double-digit discounts in the low teens. If the trust does not continue to perform well or investors are bearish on Europe the discount might go back out or not get any tighter. And even if it does tighten, analysts at Winterflood think that it may take some time before the trust is trading at a premium rating given the nature of its shareholder base and the weak demand for European equities. 

However, even if the discount to NAV doesn't tighten much more, if the share price does well investors in the trust can still make good returns, especially if they have a long investment horizon – as you should if you invest in overseas equities. And the trust's select basket of companies should hopefully do better than the wider European economy over such periods.

So if you are seeking growth over the long term for a reasonable charge, and want to take advantage of quality companies at depressed valuations, Baillie Gifford European Growth Trust looks like a good option. Buy.