Declining discounts: the investment trusts that are no longer cheap

It has become harder to pick up a bargain. Faith Glasgow runs through examples of trusts that now carry more expensive price tags.

Bargains among investment companies are hard to come by these days. The closed-ended sector as a whole has seen a major re-rating since this time last year, as figures from Morningstar make clear: on 23 June 2020 it sat on a weighted average (based on the size of the trust’s assets) share price discount to net asset value (NAV) of 4.2%, and a year later it is trading at a premium of 7.9%.

As a result, says Kepler Partner’s Thomas McMahon, many trusts look expensive relative to their recent past. Several factors have contributed to this trend. In part, McMahon suggests, the trusts that have seen the biggest bounces were the most unloved in the midst of lockdown a year ago, and those that took longest to respond after the vaccination programmes got under way and the market picked up – UK trusts being a case in point.

Winterflood data for 23 June shows the weighted average discounts for all the UK equity (and equity/bond) sectors are well below their 12-month averages.

“The ‘reopening trade’ has been popular as investors have sought to benefit from UK domestic companies that can re-energise their businesses as the Covid-19 restrictions are lifted,” observes Andrew McHattie, who publishes the Investment Trust Newsletter.

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McHattie and McMahon both pick out a number of UK smaller companies trusts. One notable example is Odyssean Investment Trust (LSE:OIT), trading at a 3.6% premium against a one-year average -4.9% discount.

Another is Strategic Equity Capital (LSE:SEC) (on a discount of -8.2% now, compared with a one-year average of -18%). It has far outperformed the indices, with share price appreciation of 62% over one year, compared to 21% for the FSTE All-Share and 46.4% for the Numis Smaller Companies ex IT Index, according to McMahon.

McHattie also highlights Invesco Perpetual UK Smaller Companies (LSE:IPU) (trading at -7.3% now, compared with -13.2% over one year) and River and Mercantile UK Micro Cap (LSE:RMMC), whose discount has come in from a -15.5% one-year average to -4.6%. However, he warns: “It is possible these re-ratings might reverse once market attention moves on to a different theme.”

But McMahon is more upbeat about the inherent value still in the market: “The UK still looks cheap at an index level, and arguably has much more to run, so these narrower discounts shouldn’t necessarily frighten off investors.”

It has not all been about the post-pandemic bounce. McHattie highlights the focus on environmental, social and governance factors (ESG) among a growing number of trusts, “tapping into what is very much the zeitgeist of the moment”. 

One example, Mobius Investment Trust (LSE:MMIT) – which specifically targets emerging markets companies where ESG improvements can lead to market re-ratings – has seen its own discount come in as well, from a one-year average of -6.7% to -2.9%. 

Dunedin Income Growth (LSE:DIG) is another good example: “It has adopted an explicit objective to adopt sustainable and responsible investing criteria that has been welcomed by investors, and has seen its discount improve from a one-year average of -5.2% to -1.9%.”

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However, Ewan Lovett-Turner, head of investment companies at Numis, makes the point that by no means all equity trusts have enjoyed such a narrowing of discounts. “In recent weeks we've seen the discounts on a number of equity investment companies widen, in part reflecting the de-rating of some growth-focused (particularly Baillie Gifford) trusts,” he points out.

Overall, he says, equity trusts are trading on a -6.4% discount, narrower than the 10-year average of -7.4%, but much wider than in January 2021 when they reached a 10-year tight discount of -2.8%. “I’m more asking where buybacks/discount control mechanisms will start to kick in to protect discounts,” he adds.

Spreading the net to include private as well as listed equity trusts, McHattie identifies strong current interest in trusts investing in the ‘pre-IPO’ growth company sector. These include Chrysalis Investments (LSE:MERI) on a premium of 13.4% and Baillie Gifford’s Schiehallion Fund (LSE:MNTN) on a premium of 21.8%. 

“These trusts have both performed well, with a string of notable successes, but it remains to be seen how they will perform over a full market cycle,” he says. “One point to consider carefully is whether the quoted NAV is realistic. The NAVs of trusts investing in unquoted companies will usually lag the reality, as they are based on periodic valuations that may be out of date.”

McMahon also has an eye on the broad private equity space. He believes Oakley Capital (LSE:OCI) is optically expensive, on a 13% discount compared with a one-year average of 28.2%. 

“We think the market is belatedly recognising the momentum in the portfolio and the value in private equity,” he comments. Moreover, “with the latest NAV reported in December, OCI’s discount to its current NAV is potentially much wider, and so 2021’s 25% share price rally may not be over”.