Is 2025 the year to invest in cheap UK trusts?

With lots of great UK companies trading on ‘silly valuations’, Thomas McMahon at Kepler Trust Intelligence discusses whether to invest. He also talks about star trusts and his outlook for the next year.

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Lee Wild, head of equity strategy, interactive investor: Hello. With me today, I have Thomas McMahon, head of investment companies research at Kepler Trust Intelligence. Hi, Thomas.

Thomas McMahon, head of investment companies research at Kepler Trust Intelligence: Hi Lee.

Lee Wild: Great to have you with us again. Last year when we spoke, we talked about the fantastic year for most equity markets, especially US technology. 2024 was another belter. US tech's up over 20%. The S&P 500 has matched last year's stellar performance, the UK another modest gain. What have been your highlights of 2024?

Thomas McMahon: Well, you're right, Lee. It has been another really good year for those people who were invested. I suspect a lot of people probably weren't invested because if you think back a year or so ago, cash rates were really quite attractive, and in the investment trust space, discounts were very wide, perhaps reflecting the fact that investors were really sitting on the sidelines. There was a lot to worry about, and yet we've had a really great year, which I think is a reminder that optimism is a helpful bias usually as an investor.

I think the highlights, if we look at the market level, has been artificial intelligence (AI). Now, it was a 2022 story in the beginning, but what we saw this year was some validation that this was really going to change sectors and industries across the stock market, not just technology. I would point to the massive investment by mega-cap US tech stocks in AI. I think that was the most significant moment for me.

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I think looking at the investment trust sector, if you think back to 2023, everything was on a discount. Even the old favourites, the retail favourites, the standout performers, everything was out of favour. And what I think the highlight for me in 2024 has been, towards the end of the year we started to see some of those strong long-term performers, those retail favourites, wealth-manager favourites, have started to come back on to a premium.

So, a good example is HgCapital Trust Ord (LSE:HGT). Private equity, so something that people are worried about. Growth stocks, something that people worried about. It's now started to trade back on a premium quite regularly, having been on, I think a 20%, 25% even discount last year.

Well, City of London Ord (LSE:CTY), a very different investment trust. Over the last 10 years has almost always traded on a premium. Last year it went out to a wide discount, but it's now starting to trade back on a premium. So, I think we end the year in a much more optimistic space in the investment trust sector.

Lee Wild: Which investment trusts have been your stars of the past year?

Thomas McMahon: Well, I think you have to celebrate and acknowledge the success of Manchester & London Ord (LSE:MNL). So, it's a technology-focused investment trust and it's much more concentrated than most people would be comfortable with perhaps. It has 30% or so in NVIDIA Corp (NASDAQ:NVDA), but that's clearly been absolutely the right call, and I think at the time we're speaking, it's up 45% on a net asset value (NAV) basis

Yet I would also highlight JPMorgan American Ord (LSE:JAM) almost for the opposite reason. So, we're always told that the US market is so efficient that you can't outperform with active management. Well, JP Morgan American has outperformed the S&P 500 and it's done that without being overweight mega-cap tech stocks. It's got two portfolios, one growth, one value, managed by different managers. And it's pretty impressive to see it doing so well without taking those big positions in tech.

And maybe a final one. Golden Prospect Precious Metal Ord (LSE:GPM), something very different. Gold mining has been a sector that has really been out of favour for a while. The gold price has been strong, but the miners have lacked for a number of reasons, but distrust has kind of kept on ploughing that furrow and really been rewarded. I think at the time we're speaking, it's up around 33% or so.

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Lee Wild: So we've had a UK Budget, and a US election within a week of each other. Stock markets have responded very differently. Wall Street rocketed, the FTSE 100's disappointed. What's your outlook for the next 12 months?

Thomas McMahon: Well, there's a lot of uncertainty around what a new US administration means for stock markets. I think sometimes it pays to simplify things. You're going to have a president who really wants the stock market to go up. He made it clear with what he said last time he was in office. He views it as a matter of personal pride, and he's going to have all the levers to pull. So, I would suggest that's pretty bullish.

I would expect him to cut corporate taxes. I would expect him to encourage US corporates to do more business in the US, which again should be good for the US. So, I think the outlook for the US is really strong and the large-cap tech companies that are so important to the S&P 500 now have delivered really good results this year. So, I think the US set-up is strong.

As for the UK, our government is less concerned with the stock market. It's clearly not a priority. It's just added on a cost to companies via national insurance contributions going up. So, it's hard to get too excited. What we do have is cheap valuations, of course, and we do also have some great individual companies, lots of them. But it's that valuation element that is perhaps most interesting.

Lee Wild: So, what about the UK? Is it still worth considering? I mean, there's little doubt that it trades at a discount to valuations on other global markets, has done for a few years now, but with plenty of factors at play, not least a new Labour government. You've got the recent Budget, possible US tariffs. Do you think the UK is a buyer for 2025?

Thomas McMahon: It's hard to say it's a buy for 2025, but I do think it's a buy and lock it away. I think it's interesting. If you look at an index level, the mid-caps and the small-caps, the valuations aren't really that unusual for the last 10 years. But it's definitely the case that lots of individual companies are at silly valuations, and that's being reflected in M&A.

And in fact, a lot of the managers that we talk to will tell us that their big problem is that even if they're being offered a 30% premium to the share price for their companies, they still feel it undervalues the business because that's how poor valuations are in some sectors. So, I think, that valuation element makes the UK really attractive.

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What's the catalyst? I don't think the Labour government is massively significant. But I think they haven't helped by, kind of making some more negative sentiment around the UK stock market, and I think it's really sentiment that's driving UK versus rest of the world.

What I would say is perhaps one possible source of optimism. I think overseas investors often view the FTSE 250 as a play on the domestic economy. It's not really true, it's maybe 50-50 revenues UK and overseas. Perhaps the interest in M&A and interest in the UK as a source of cheap investments, perhaps that could be the new perception.

Perhaps we could start to see some momentum just by investors starting to look at the UK and thinking, well, this market is dying, is dwindling and you should make the best of it. Maybe that will start to bring the money back in. Because often in these cases, we don't really need anything to happen for sentiment to change, it just needs to be nothing new negative.

Lee Wild: Thomas McMahon, head of investment companies research at Kepler Trust Intelligence. Thanks very much for joining me today.

Thomas McMahon: It's a pleasure.

Lee Wild: And thank you for joining us, too. And don't forget, you can see more ii fund manager interviews on the ii YouTube channel.