Value to be found in discounted small-cap investment trusts

Small-cap and fledgling investment trusts are now near universally trading on double-digit discounts.

The trusts suffered a savage de-rating as investors begun favouring large-cap stocks. But the de-rating has been indiscriminate and has left some attractive investment opportunities in its wake.

Recent volatility and concerns over a liquidity crisis have also hurt sentiment in the sector, with some investors wondering where the support will be for smaller firms in troubled times.

By mid November the 13 investment trusts in the AIC UK Smaller Companies sector were trading on an average discount of 15.3%, while the three trusts in the AIC Fledgling sector, Active Capital , Eaglet and Gartmore Fledgling, were faring slightly worse, averaging a 15.6% discount.

Eaglet , which until October was managed by Unicorn Asset Management founder Peter Webb, has seen a well-documented corporate action led by Knox D’Arcy, QVT and Laxey, who together with other arbitrageurs control around 39% of the trust.

After its EGM on 11 December, the arbs had successfully managed to put three new directors onto the board, with a potential brief to change the investment strategy to improve performance.

Perhaps in acknowledgement of the difficulties facing the sector, Gervais Williams’ £98 million Gartmore Fledgling trust is looking to boost its investment powers by having the flexibility to invest up to 20% of the portfolio in companies that have dropped down to AIM from the main index.

Renowned arbitrageur Laxey Partners has taken a stake in the third fledgling trust, Active Capital managed by Bill Brown of Bluehone Investors, which has a commitment to grow its share price from 100p at launch to 222p by its annual general meeting in 2009.

The last three years have been weak periods for all three managers but their longer-term track records are strong.

This, coupled with the fact all three trusts seem to be facing shareholders or using strategies set on closing the discounts, make all three trusts an option as an each-way bet.