European small caps should do well in any bull market.
Investing in Europe might not seem as racy as the private life of Silvio Berlusconi, but IMA sector analysis currently shows that Europe excluding the UK is ahead of the UK All Companies sector over all periods, namely 1 month, 3 months, 6 months, 1 year, 2 years, 3 years and 5 years. Further, we might draw a lesson from Nicolas Sarkozy on the outperformance of things smaller.
Montanaro Investment Managers quote in their internal research of the Hoare Govett Small Cap index that small caps have, over 55 years of data, achieved impressive outperformance over large caps in bull markets. They reckon the outperformance is 7% per annum during such periods. So, if we are entering a bull phase, it's certainly worth looking at small caps rather than large caps.
Europe is making the pace
Over the last six months, UK Small Caps (44%) and European Small Caps (43%) top the performance tables. Over the last five years the story is rather different with European Small Caps well ahead -- 85% vs 35%. The strength of the euro has no doubt played a part in this.
This trend could continue. The UK has a poorer comparative outlook compared to, say, emerging markets, through high public and individual levels of debt. Europe, or France and Germany at least, came out of recession in August and we wait to see the benefits of the new German pro-business alliance elected in last month.
Choose an Investment Trust
Whilst the menu isn't extensive, the performance of the four European Smaller Companies investment tursts has been very good over the last six months and also over five yeas. My favourite of the four is the smallest by market capitalisation -- Montanaro European Smaller Companies (LSE: MTE). What's interesting about this trust is that its run by a management stable that also runs a UK equivalent -- the Montanaro UK Smaller Companies (LSE: MTU) -- so you can compare the two.
Both have good track records, beating the IMA sector rates for six months and five years -- but again the European trust is ahead of the UK trust. Montanaro European Smaller is up 52% in six months, is on a 10% discount and pays a dividend of 1.9%. Montanaro UK Smaller is up 48%, with a good discount at 17% and 3% dividend.
A touch of Warren Buffett
I have to say I like the Montanaro European Smaller Trust's investment philosophy. It focuses on small caps with a value below €3bn and describes itself as a 'bottom-up' stock picker that generates its investment ideas internally. It has over 8,000 companies within its universe to choose from. So, as it says, it's spoilt for choice. It likes companies that are profitable, have high margins and where there is sufficient public ownership of shares to gain a holding.
It typically leaves aside complicated technology and blue sky companies and looks for niche franchises with competent and experienced management. Other items on its checklist include sound finances, a good order pipeline, simple business models, high barriers to entry, a dominant market position that ensures pricing power. If this has a ring of familiarity, it is because Charles Montanaro, founder and manager, claims openly to adopt a Warren Buffett approach.
And the others?
TR European Growth (LSE: TRG) run by Stephen Peak also has a good long-term track record (54% over 6 months and 92% over 5 years) and trades at an 8% discount. France and Germany make up roughly 15% each of the portfolio. He's been running the trust since 1990, and has also done very well recently with the Henderson European Absolute Return Fund.
JP Morgan Euro Fledgling Trust (LSE: JFF) has also been around since 1990. It is the largest of the four. It has no yield, a discount of 16%, and the best five-year performance with 157% growth. Switzerland and Netherlands both account for 13% of its holdings.
European Assets Trust (LSE: EAT) is managed by Foreign & Colonial. It has the lowest discount at 6.6% and a fair dividend at 4%. It has a high distribution policy, and pays quarterly dividends. None of the large European economies is a dominant holding, but Switzerland and Italy account for 13% each and it has 10% in Spain.
Among the OEICs then Baring Europe Select has the reputation for being the best stock-picker. Of course, being an open-ended fund it offers no discount.
If we have a market dip up to Christmas, I reckon it would be a good time to diversify some money into the European Small Cap sector.
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