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Top Trusts: how I found five investment trust bargains

Gavin Lumsden shows a way of identifying interesting equity investment trusts trading on cheap valuations (or discounts to net asset value).

Top Trusts: how I found five investment trust bargains

Buying investment trusts when their shares are cheap and trading at discounts below their net asset value can be a good way to make money. The trouble is there aren’t as many cheap trusts as there used to be and buying trusts on discounts often means buying them when they are out of favour or underperforming.

Using analysis from Winterflood Securities this video shows one way to sift through all the equity investment trusts in search of cheap trusts that could be poised for a turnaround and a re-rating.

Can't watch now? Read my script

Hello I’m returning to the subject of investment trust discounts to show how you can find potential bargains in investment trusts investing in equities – or shares – today.

To recap: a discount is when an investment trust share price trades below its net asset value.

Buying investment trusts when their shares are cheap in this way can be a good way to make money. The trouble is there aren’t as many trusts on discounts as there used to be.

Analysis by Winterflood Securities shows over a third of investment trusts trade on premiums which are the opposite to discounts when an investment trust share rises above its net asset value as a result of investor demand.

In 2008, before the financial crisis, only 14% of investment trusts were expensive in that way. At the end of October there were 35%.

Still that leaves us with 200 trusts on a discount of some sort. We can turn Winterflood’s analysis on premiums on its head to help us sift through them all.

According to the firm the main characteristics of equity investment trusts on premiums or narrow discounts are:

Many are equity income funds – popular because of the high yields they offer when interest rates are low. Some have zero discount policies to prevent their shares falling to a discount. Others are recent launches. Many are good performers. Or have benefited from being in a fashionable sector. Sometimes a change in fund manager or investment approach has boosted their appeal.

As we’re hunting for discounts we can reverse all those traits and look for: trusts that invest in equities, but aren’t UK equity income or older than five years, don’t have zero discount policies and have performed poorly and had a recent manager change.

So we drop trusts investing in debt, infrastructure, hedge funds and bricks and mortar. We also say goodbye to private equity trusts even though there are big discounts in this sector that look interesting.

We cut all UK Equity income trusts apart from three on big discounts. We ignore trusts launched in the past five years. We set aside trusts with zero discount policies. And we exclude all trusts that have beaten their benchmark stock market index over five years.

That leaves us with 75 old, underperforming investment trusts. There are lots of potential opportunities here: for example, distressed mining trusts for the brave, contrarian investor.

But we’re going for one final cut to focus on trusts that have had a change in fund manager or investment approach since January 2014 and which still remain on a big discount.

That leaves us with just five trusts. They are the Monks and Scottish investment trusts in the Global Growth Sector, Aberdeen Japan, Invesco Asia and Templeton Emerging Markets. All are worth further consideration.

My current favourites are Monks where the new manager Charles Plowden is turning it into a ‘best ideas’ fund for Baillie Gifford, the investment group he works for. Recent performance appears to be improving but this hasn’t been reflected in the shares much which trade at a 12% discount to net asset value.

I also fancy a punt on Carlos Hardenberg turning round Templeton Emerging Markets. He’s just taken over from Mark Mobius so there’s no sign of improved performance. I have to say the analysts I’ve spoken to aren’t convinced so it’s just a hunch.

Hunch or no hunch, I hope you’ve found this useful as you look for the next investment trust bargain.

13 comments so far. Why not have your say?

MP

Dec 08, 2015 at 14:40

Monks also looks interesting because of the strength of the Baillie Gifford research team but its odd that its performance was allowed to lag for quite so long.

However, discounts of 10 per cent are hardly must-buy discounts!

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Maverick

Dec 08, 2015 at 16:25

I am still totally mystified about investment trust "discounts". You can't buy an investment trust's shares at the "net asset value" price even if you want to.

Nobody has ever been able to produce the information for me which would show that buying a trust's shares at a discount has an actual effect on the performance of the trust's share price.

Also how is "net asset value" calculated? Is it a conflation of the share price of the constituent companies, or the actual net asset value of the constituent companies - which is something completely different. Just to take one example, Persimmon Homes has a share price of 1950p and a net asset value of 705p.

At the end of the day the true price of anything - books, houses, works of art, even brussels sprouts - is what someone is prepared to pay for it.

Remember that there may be a good reason why an investment trust has a "discount". And if the markets don't like a share, it takes a fair while for the market sentiment to change.

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MP

Dec 08, 2015 at 16:47

Maverick: Buying at a discount is relevant if the share becomes more popular and the discount narrows as a consequence of more people buying the shares and pushing the share price up relative to NAV. This doesn't always work and as you say you often have to wait for a long time for the sentiment to change. Also, when the market falls, the discount often narrows but the share price stays the same.

The reverse is also true. You can buy a share and then the discount widens. Either the NAV goes up but this is not reflected in the share price or the share falls from favour and the share price drops while the NAV stays the same.

All of this is called the "discount risk" and investment advisors usually hate it because it just adds an additional level of uncertainty to their investment advice...hence the trend towards zero-discount mechanisms to mirror OEICs

Where there's risk some see opportunity and therefore buy at wide discounts hoping that sentiment towards the share will change.

The other reason for buying at a discount, regardless of discount risk, is that you are able to buy £100 of assets for, say, £90. This means that you get dividends from £100 of investment but you've only paid £90. This means that you either get a yield boost or better quality investments in the underlying portfolio for the same level of yield.

Years ago, when discounts were typically 15-20%, discount investing had some merit but these days discounts are so small its hardly worthwhile.

What has become more important is "premium avoidance". Avoiding buying shares that are temporarily trading at a price that's higher than their normal premium/discount....this takes us back to "discount risk" again.

The underlying NAV is rather meaningless to the investor. It has more meaning to the fund manager who bases their commission and performance track record claims on it.

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dab

Dec 08, 2015 at 16:51

oryx international growth is a good example of how a narrowing discount has accelerated share price growth in recent years.

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JohnR

Dec 08, 2015 at 17:05

The thesis seems to be an assumption that the IT share price will eventually revert to something approaching the NAV over a long enough period and may even go to a premium if the trust becomes popular, thus boosting any NAV gains or diluting any NAV losses over that time.

The problem is that in order to capture a potential gain from the narrowing discount requires nifty market timing, buying and selling at critical points to obtain the benefit from that particular element while it's there for the taking.

Even if you manage that though, it says nothing about the IT share price or NAV itself which may be lower than purchase, even as the discount narrows.

Surely that sort of market timing and effort would be much better suited to individual stocks?

None of this sits well with me as a LTBH investor holding income investment trusts, so I tend to look at other aspects first and the premium/discount as very much a peripheral consideration.

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MP

Dec 08, 2015 at 17:57

JohnR: I agree. One can hang around for ages waiting to buy a trust at a big enough discount but still end up paying more for it that one might have done when it was at a premium months or years earlier. In a way, watching the share price relative to its long term performance trend has more predictable results than trying to time discount purchases.

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Maverick

Dec 08, 2015 at 17:57

MP - I fully understand the theory (for which I thank you), but I have yet to see hard figures. You say you can buy £100 of assets for £90, but what if the £100 assets were overpriced by 15%?

Before I became a pensions solicitor I spent many happy years managing a large secondhand bookshop. I used to get dozens of people putting a book down on the counter saying "So-and-so down the road is selling this at £50. You're selling it for £20." I would wrap the book up and reply "Yes, and I've made a decent profit. Whereas you can go back to So-and-so in 20 years' time, and that book will still be on their shelves at £50."

The true price of an item is what somebody is prepared to pay for it. That's why net asset values, and hence discounts, are a waste of time and brain-power when it comes to investment trusts.

If unit trusts didn't exist nobody would care tuppence about discounts.

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MP

Dec 08, 2015 at 18:17

Maverick: I agree that things are only worth what someone is willing to pay for it. However, if you had an IT invested only in one single, quoted blue chip company and the IT only had a very modest number of the blue-chip's shares, then you could calculate the NAV of the IT's "portfolio" and be fairly confident about it. The IT share would probably sell at a very slight discount.

When ITs have complex investment structures with unquoted shares, derivatives, foreign currencies etc it becomes much more uncertain what the real NAV is.

If you ignore NAV...as I do... and look at discount and share price, the discount is a sort of "sentiment indicator"...albeit weakly. If sentiment changes and the discount narrows this narrowing can attract more investors and drive up share price. This becomes a type of momentum investing but I don't think its common.

Ultimately, as investors we live in the world of share prices not NAVs whereas those who run our ITs and the industry that comments on them is more concerned with NAVs...and that's because we are interested in different things!

For us, NAV is a red-herring and discounts have become one since they narrowed. But then so many things about ITs are becoming red-herrings.

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dab

Dec 08, 2015 at 18:31

The other effect of discounts is to enhance the effective dividend yield paid to shareholders of the IT who buy at a discount. Conversely buying at a premium reduces the effective yield of the underlying investment.

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richard tomkin

Dec 08, 2015 at 22:17

Discount or premium obsessives are not taking a proper long term view.I have held shares in Scottish Investment Trust since 1970.I neither remember nor care whether I paid over or under the asset value 45 years ago!

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Maverick

Dec 08, 2015 at 22:46

Scottish Investment Trust total gain over the last 10 years 46.5%, plus 2.1% annual dividend, say annualised 6.75%.

The Trustnet website's excellent advanced filter system tells me that there were 111 investment trusts that beat 67.5% over five years, let alone over ten. I think on balance I'd rather have had Biotech Growth Trust over the last ten years than Scottish.

Something that was an excellent performer 45 years ago may now be a total dog. The world is an entirely different place now. Loyalty may be a great virtue, but not when it hits you in the wallet.

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huudi

Jul 18, 2016 at 08:33

Maverick, also consider the life of the trust, ITs may be floated with a fixed life span(usually 5-15 years), this was common a few years ago. At the end of this time the IT would wind-up and the NAV distributed, in this case you should profit from buying at a discount.

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huudi

Jul 18, 2016 at 09:03

Around ten years ago Templeton did allow shareholders to 'cash-in' at a NAV of ~700p, since then the chart has been downhill. This was due to pressure from major investors, any such request from us would be met with derision.

Bear in mind that should interest rates begin the overdue climb then this will have an immediate effect, much of the money invested is there only because there is nowhere else.

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