Liontrust European Enhanced Income Fund

October 2019 review

The Liontrust European Enhanced Income Fund returned 2.2%* in sterling terms in October. For comparison the MSCI Europe ex-UK Index returned -1.6% in sterling terms and 1.3% in local currency terms, while the average sterling terms return of funds in the IA Europe ex-UK sector was -1.3%.

 

The Fund’s most recent income distribution was announced on 31 August 2019, taking the Fund’s 12 month income yield to 4.7%. The Fund targets an income level of 1.25x the yield on the MSCI Europe ex-UK Index. The index yielded 3.5% over the same period.

 

October’s sterling-terms loss from investing in European equities resulted from strength in the pound, which appreciated by 2.5% relative to the euro, driven by optimism that the Brexit process was approaching the endgame, albeit the hurdle of a new election now has to be surmounted.  In local currency terms the MSCI Europe ex-UK Index rose 1.3%.

 

Trade tensions remained near the top of investors’ list of concerns and markets eagerly awaited news of a breakthrough in US-China trade talks following a provisional agreement that Trump described as a “substantial phase one deal”. In the meantime, there were some signs of weakening in macroeconomic data.  For example, HIS Markit’s index of eurozone manufacturing dropped to 45.7, the lowest level since October 2012. Any reading below 50 indicates a contraction.

 

At the corporate level, Q3 earnings season dominated. Within the Fund, BE Semiconductor Industries (+12.0%), a manufacturer of assembly equipment for the semiconductor industry, was the biggest riser on the back of results. It had expected a heavy fall in Q3 sales due to “customer caution in light of global trade tensions” but while it did see a 3.2% quarter-on-quarter contraction to €89.7m, this was well ahead of the company’s guidance of a 10% fall. The positive surprise came from higher-than-anticipated shipments to Chinese subcontractors making mainstream electronics applications. There are some signs the market is stabilising, with orders (€82.2m) roughly flat versus Q2.

 

Daimler (+11.6%) also rallied after announcing a 6% increase in unit sales to over 839k vehicles in Q3, with revenue and operating profit both rising 8% to €43.3bn and €2.7bn respectively. Cash flow trends are less promising; free cash flow was -£0.5m in the first nine months of the year as a result of adverse working capital movements and a high level of capital expenditure. The company’s new CEO used the Q3 statement to reiterate Daimler’s commitment to reducing costs and improving cash flow, even as the major European car giants make the transition to electric vehicles, which entails large capex projects.

 

The reaction to Q3 numbers from Norwegian insurer Gjensidige Forsikring (-10.5%) was less positive. Quarterly profit before tax rose by nearly a third year-on-year following a big improvement in its underwriting result. There were fewer large losses and the “underlying frequency loss ratio” also improved due to better weather conditions. However, the NKr1.27bn number missed analyst expectations that ranged from NKr1.36bn to NKr1.70bn, due to weaker investment returns.

 

The portfolio’s largest fall – 1&1 Drillisch (-18.6%) – came not from quarterly results, but from an adverse arbitration ruling. The virtual telecoms network operator unexpectedly lost an €85m dispute with Telefonica Deutschland over pricing for the use of its network. As a result, Drillisch lowered its 2019 earnings before interest, tax, depreciation and amortisation forecast from €780m to €690m to reflect its increased costs.


Share weakness for food giant Danone (-10.6%) resulted from a small downgrade to full year sales guidance from 3% to a range of 2.5% - 3.0%, with the company referencing growing geopolitical uncertainties. In Q3 it recorded 3.0% like-for-like sales growth to €6.42bn, a rise that was driven by price increases and product mix changes rather than volume, which fell 1.6%.

 

During October we added a new holding in SIG Combibloc to the Fund. The company is the second largest supplier of aseptic packaging globally, after Tetra Pak, and meets all the criteria we typically look for in an income stock – a strong economic moat, high barriers to entry, a robust balance sheet, and a progressive dividend policy. We believe that product innovation and superior machine setup & operation versus the Tetra solution should see the company gain market share, and new product markets recently entered provide attractive growth angles.

 

Positive contributors included:

BE Semiconductor Industries (+12.0%), Daimler (+11.6%) and Banca Farmafactoring (+10.2%).

 

Negative contributors included:

1&1 Drillisch (-18.6%), Danone (-10.6%) and Gjensidige Forsikring (-10.5%).

 


 

The Fund’s covered call strategy remains on pause until more attractive premium rates present themselves.

 

The Fund’s primary share class is currency-hedged in order to provide insulation from movements in the value of the euro and other European currencies. The euro depreciated by 2.5% against sterling in October.

 

Discrete years' performance** (%), to previous quarter-end:

 

 

Sep-19

Sep-18

Sep-17

Sep-16

Sep-15

Liontrust European Enhanced Income
I Hedged Acc

3.9

-1.5

18.0

-4.8

13.7

MSCI Europe ex UK

5.8

1.3

21.4

20.0

-1.6

IA Europe Excluding UK

2.2

1.9

21.9

18.4

3.6

Quartile

2

4

4

4

1

 

*Source: Financial Express, as at 31.10.2019, total return (net of fees and income reinvested), bid-to-bid, institutional class. Non fund-related return data sourced from Bloomberg.

 

**Source: Financial Express, as at 30.09.2019, total return (net of fees and income reinvested), bid-to-bid, primary class.

 

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the European Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. Investment in the Liontrust European Enhanced Income Fund writes out of the money call options to generate additional income. These call options will be “covered”. Unitholders should note that potential capital growth of the Fund would be capped if these call options are exercised against the Fund and the Fund’s capital returns could therefore be lower than the market in periods of rapidly rising share prices.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, November 18, 2019, 10:13 AM