European Opportunities Trust: Whacked By Wirecard

I’ve been meaning to take a closer look at European Opportunities Trust for a while. It’s been a great performer for nearly 20 years, but its largest holding, Wirecard, hit the headlines last week for all the wrong reasons.

European Opportunities has now sold its entire stake in Wirecard. But the trust took a heavy hit, both in terms of money and reputation.

Key Stats For European Opportunities Trust

Figures are as of 19 June 2020 unless otherwise stated:

• Founded: November 2000
• Manager: Alexander Darwall (aged 57, manager since launch)
• Management firm: Devon Equity Management
• Ticker: JEO
• Benchmark: MSCI Europe
• 10-year net asset value return: 248%
• Share price: 718p
• Indicated spread: 716p – 720p (0.6%)
• Market cap: £775 million
• Discount to net assets: 8%
• Costs:  OCF 0.9%, KID 1.0%
• Net cash: 1% as of 31 May 2020
• Historical dividend and yield: 5.5p and 0.8%, paid annually
• Results released: Feb (interims) and Sep (finals)
• Sector: Europe (1st out of 8 over the last 10 years)
• Links: Website and AIC page

Crosswires

European Opportunities, known as Jupiter European Opportunities until last year, was launched in November 2000 and it’s been the best performing European investment trust since then. It’s been run by Alexander Darwall from inception.

Last year, Darwall and his associates set up a new investment company, Devon Equity Management. The board of European Opportunities decided to follow him and they transferred the management of the trust away from Jupiter.

For some reason, the trust’s ticker has remained as JEO, despite the move from Jupiter and EOT seemingly being available.

Wirecard is a German payment technology firm and it’s long been Darwall’s biggest position. It has been a listed company for nearly 20 years but has rarely been far from controversy and it was often targeted by shorters.

The Alphaville column on the Financial Times website has been writing about Wirecard for five years with a series unsubtly tagged as The House Of Wirecard.

After one particularly damaging story in early 2019, Wirecard even went as far as taking out a lawsuit against the FT.

Wirecard’s shares plunged in April of this year on auditing concerns and then they collapsed again last week after 1.9 billion euros of cash appears to have gone missing. The CEO of Wirecard has since resigned.

Riding it up

European Opportunities bought its first tranche of Wirecard shares in December 2007, paying 9 euros.

By May 2009, it had a 1.0% position, valued at £1.8m.

It’s been one of the trust’s largest holdings since 2013 and for a brief time accounted for 17% of its entire portfolio.

The share price of Wirecard peaked at just over 190 euros in the summer of 2018, so at one stage it was probably a 20-bagger for Darwall.

Riding it down

At the start of this year, with Wirecard’s share price back down to around 100 euros, Darwall apologised for letting his position get so oversized.

As of 31 May 2020, Wirecard was still the trust’s largest holding at and represented just over 10% of its net assets. It was probably worth £105m just prior to the news of the missing cash.

Darwall sold his entire holding on 18 June. In a statement, Devon Equity Management said:

At the time of publication of KPMG’s report on the company’s internal investigation in March 2020 we engaged directly and extensively with senior management and the board. We were satisfied that its management would address the alleged issues identified in full. In retrospect this conclusion was a mistake, for which we apologise. When we ceased to believe in the investment case for the company on 18 June, we sold the position in its entirety.

Clearly the collapse in this holding is deeply disappointing. We will continue to follow developments, but our focus looking forward is to ensure that our investment portfolios deliver relative to their investment objectives and to learn from our mistakes. We are excited by and absolutely committed to the success of the strategy.

I guess that when, at one point anyway, you’ve made 20 times your money on a stock, it’s a lot harder to be impartial.

A small profit overall

The trust’s net asset value dropped 7.5% on 18 June, so I reckon the average sell price was around 30 euros.

Devon said its blended purchase price was 27 euros, with its most recent purchase in February 2019. But the trust would have made a handsome profit when it trimmed its position in 2017 and 2018.

Wirecard’s share price has fallen by another 50% since Darwall sold. It closed on Monday at 14.5 euros.

As you might expect, European Opportunities’ share price reacted sharply, too. It was 777p on Wednesday evening and finished the week on 718p.

But its shares fell as low as 656p on Friday morning and one of the trust’s directors, Sharon Brown, managed to buy £10,000 of shares at 676p.

Performance

It’s easy to forget that Darwall still has a great track record, even after the recent goings-on at Wirecard:

Trust	Performance Nov 2000 to Jun 2020
European Opportunities	646%
Fidelity European Values	571%
Henderson EuroTrust	361%
Henderson European Focus	278%
Baillie Gifford European Growth	138%

The MSCI Europe index is up around 160% over the same timeframe. That means Darwall has returned 10.8% a year versus 5.0% for European markets.

That’s a chunky level of outperformance.

What’s more, it’s been achieved without investing in the soaring US market of recent years.

10.8% a year from 2000 to 2020 means European Opportunities has beaten most global trusts over the timeframe, except Scottish Mortgage and Mid Wynd.

It’s been pretty consistent, too. European Opportunities has only underperformed its benchmark in three years since it launched (the years to May 2009, May 2017 and May 2020).

The figures for the full year to May 2020 aren’t in the above table but European Opportunities lost 7.0% while its benchmark fell 2.5%.

In all three years, therefore, the underperformance has been less than five percentage points. In other words, even when it’s lost some ground against the index, it hasn’t been that far behind.

The year ending May 2021 hasn’t got off to the best start, of course, so that could turn out to be number four.

Investment process

A recent note from Kepler contains this useful illustration:

[Darwall] is a bottom-up investor; using rigorous fundamental analysis to identify companies that can retain their high growth characteristics and profitability for much longer than many other investors expect. Alexander prefers companies that have less capital intensity, use digital channels and have a large amount of intellectual property.

His focus does not, however, include start-ups or ‘preprofitability’ companies. Over any 12 month period, Alexander will buy between 10-15 new companies on average, which will represent around 0.5% of the portfolio each.

Once a company has been identified as a suitable investment, Alexander and Luca Emo research the company’s management teams to better understand them. He will then further add to the position as his confidence in the investment thesis increases. Until he believes that the growth ‘runway’ has shortened or expired, Alexander will continue to hold the position.

A key part of this process involves meeting the management teams – in the last year alone Alexander and Luca met around 190 companies.

A podcast at Fund Calibre adds a bit more colour about the decision to set up Devon Equity Management:

Richard Pavry [Devon’s CEO], Luca Emo [deputy fund manager] and myself have worked together for many, many years at Jupiter. And …. we made the decision to have a more focused, sharpened investment experience. It’s certainly going to prolong my enthusiasm and shelf life, which is what I really wanted to do.

We try to find special companies. And companies that are special are really companies that we think can flourish in different economic scenarios. Because we don’t do a lot of economic forecasting. I don’t know what the next surprise around the corner, it might be a good surprise might be a bad surprise.

And in fact, the COVID-19 episode has played to that because we never forecast this, of course no one did, but our companies, which do something special and different with strong balance sheets with lots of intellectual property and a bit less capital intensity – all those things are actually helping us at the moment. So, whilst we never forecast COVID-19, the fact that we like special companies is our best way and has, is proving to be a relatively good way of coping with this crisis.

So we’re looking at ‘Quality Growth’ here, for want of a better description. It’s pretty similar to the likes of Fundsmith and Lindsell Train, with the same focus on having a concentrated portfolio.

Portfolio

European Opportunities had 27 positions, before selling Wirecard, but its top ten accounted for around 80% of its net assets.

Here’s the summary as of 31 May 2020 with a sector and country breakdown:

And here’s the full listing:

It’s predominantly a large-cap portfolio, with just 16% in mid-caps and 1% in small-caps.

Portfolio turnover seems to have been fairly low in recent years. The 2019 accounts suggested around 15% by value of the portfolio was bought and sold in both 2019 and 2018.

The interim accounts to 30 November 2019 showed 31 holdings, of which 6 were new compared to a year previously. However, the position sizes for these were all quite small, ranging from 0.2% to 0.6%.

But some sizeable positions of 5% or so have been sold in recent months, namely Carnival, Adidas, and Amadeus IT.

Now that Wirecard has left the building, I can’t see any stocks on this list that I would have considered to be particularly controversial, although I’m not that familiar with some of the non-UK holdings.

Among the largest remaining positions, RELX is a Nick Train favourite and Novo Nordisk is often mentioned by Terry Smith.

Gearing

European Opportunities seems to run with a fairly low level of gearing. It currently has a flexible bank facility of £100m and net assets of around £900m.

£85m of this facility was drawn down as of November 2019 but the trust had a small net cash position as of May 2020, presumably due to recent investment sales. And the sale of Wirecard may have increased the net cash position a little further.

Discounts and premiums

European Opportunities has mostly traded at a discount over the past 10 years, so the current 8% discount isn’t entirely unprecedented.

However, the trust has enjoyed a premium at times, most notably from 2013 to 2015 and at times during 2018.

Charges

The fee structure has changed a bit following the move to Devon Equity Management.

With Jupiter, the management fee had been 0.75% of total assets plus a 15% performance fee.

It’s now 0.9% of net (rather than total) assets up to £1bn and 0.8% over that amount. The performance fee element has been removed.

There was a transition period up until 31 May 2020 where Jupiter continued to get its fee and Devon got 0.1%.

In absolute terms, the management fee was £7m the past two years (to May 2018 and 2019) but amounts of £7m and £13m were paid in respect of the performance fee. Other expenses came to about £0.75m.

0.9% on assets of £1bn, give or take, certainly isn’t cheap for a mainstream equity trust. So it needs to be backed up by continued outperformance.

Skin in the game

European Opportunities currently has six directors, three of whom have been on the board for quite some time: Andrew Sutch (Chairman, on the board since 2011), Philip Best (Chair of Audit Committee, since 2009), and John Wallinger (since 2000). Perhaps they gave Darwall too long a leash over Wirecard?

The board also includes the former Chancellor of the Exchequer, Lord Lamont, who has served since 2015.

The directors collectively own around 340,000 shares (worth some £2.4m), with Wallinger having by far the largest stake (256,000).

Darwall owns 3.64 million shares in European Opportunities, currently worth around £26m, so his interests should certainly be aligned with the trust’s shareholders. He appears to have owned a similar number of shares since at least 2008.

At 57, he should also have many more years at the helm and seems genuinely enthused about setting up a new investment business. Luca Emo, his deputy, is 39.

There is a non-compete clause with Jupiter, so European Opportunities should be the focus of attention for a little while. An open-ended fund has been set up, but it has assets of less than £100m, and Devon also appears to run some money for institutional investors.

According to filings at Companies House, Darwall seems to own 80% of Devon, with Luca Emo and Richard Pavry owning 10% each.

Summing up

Here is a marmite trust if ever there was one.

A lot of investors seem to write off managers who have had a one-off disaster like this or who own one business they don’t like (Tesla and Scottish Mortgage being the classic example).

They worry, with good reason some might say, that it shows that the underlying investment process is flawed.

I tend to be more naive forgiving, on the basis that all great managers have howlers now and again. No investor gets everything right all the time — or even close to it.

However, I am wary of companies that are regularly targeted by shorters, especially when it’s regarding aggressive accounting and poor cash flow rather than just excessive valuation. Far more often than not, as far as I can see, the shorters are proved correct.

Here in the UK, Globo, Quindell, and Burford spring to mind.

All that said, Darwall still has a great track record, particularly when you consider the lack of US stocks in the portfolio.

What’s more, decisive action was taken to cut the holding in one fell swoop once the situation became untenable and the appropriate apologies were issued. That’s in stark contrast to the likes of Neil Woodford who tried the keep his cracked plates spinning.

I plan to keep an eye on this one. But as its focus is Europe rather than Global, it’s less likely to find its way into my portfolio.

   

---

Disclaimer

Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.

Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!

---

Subscribe to IT Investor

Get an email alert every time I publish a new article. Your email address won't be used for anything else.

---

Spread the word...