Investment trust discount opportunities still plentiful

Fiona Hamilton rounds up some of the most attractively priced trusts across a range of non-equity sectors.

Discount volatility has added both stress and excitement to this year’s market gyrations, so far as investment trust investors are concerned. Having ended 2019 at an exceptionally narrow 2%, the average discount on the trust sector plunged from 5% to 22% during the first three weeks of March, severely exacerbating the downward pressure on trust share prices as the threat from Covid-19 became frighteningly apparent.

It then recovered almost as fast, to around 6% in mid-April, enhancing the recovery in world stock markets for trust shareholders before settling down in high single figures. 

Those brave enough to buy at the height of the carnage had the chance to secure shares in their favourite trusts in almost any overseas sector, any smaller company sector and even the technology and biotech sectors, at far wider discounts than usual, and in some cases over 20%. Few trusts escaped unscathed, with even Scottish Mortgage, Finsbury Growth & Income and RIT Capital Partners, which usually trade at premiums, briefly on offer at double-digit discounts.

Discounts on most equity sectors now look a lot less inviting given the fragile economic outlook. They remain a tad wider than before on most overseas equity and smaller company trusts, but for the global and UK equity income sectors they are back in line with the 12-month average.

In early May, there were still a few trusts on interestingly wide discounts, including Artemis Alpha, Keystone, Henderson Opportunities, Atlantis Japan Growth Fund, Aberdeen Standard Asia Focus and Fundsmith Emerging Equities. But so far as equity trusts are concerned, it is probably better to focus on the outlook for any trust’s portfolio and the abilities of its manager, rather than hunting for anomalous discounts.  

On the other hand, discounts continue to appear temptingly wide in various non-equity sectors, notably UK commercial property and private equity. Although discounts on both are well down from their March peak, in many cases they remain more than twice their average over 12 months.

The trouble is that discounts in these sectors are misleading, as most property and private equity trusts only fully update their net asset value per share every six months. So most of the indicated discounts do not take account of the probable fall in their NAVs since the start of the year.

- Investment Trust Awards 2020: Best Direct UK Commercial Property Trust

In the property sector, severe problems in the retail, hospitality and leisure sectors are damaging both current rent collection and future valuations, and there are mounting worries about offices now that many businesses have found that staff can work well from home. Even when trusts try to revalue their holdings, most of the valuers they employ caution that their calculations are subject to “material valuation uncertainty”.

In early May, broker Stifel favoured several property trusts on large premiums due to their exceptionally secure outlook, notably Assura and Target Healthcare REIT. However, Stifel was also positive about several on wide discounts, including Picton Property Income and GCP Student Living (DIGS). Stifel’s Sam King says Picton’s strength comes from its sectoral diversity – with 48% in industrial, 34% in offices, and 18.3% in retail/leisure – its low gearing, and its access to significant liquidity should the shutdown continue for long. Its yield reflects a 29.5% cut in its first-quarter dividend, which is low for the sector. As for DIGS, it has a strong balance sheet, and its high-quality student accommodation is mainly in London and Brighton, where demand has traditionally been very strong and should revive so long as the next academic year is not disrupted. DIGS has so far maintained its dividend.

Stifel also recommended shares in TR Property (TRY) when they are on a double-digit discount, on the basis that its holdings include a lot of property companies which are on a discount, so they are trading “at a discount to a discount”. This is not entirely accurate, as TRY’s portfolio includes the likes of Assura and Supermarket Income REIT which are on large premiums, and it has little exposure to the most troubled sectors, such as hotels and shopping centres.

However, it is masterfully managed by Marcus Phayre Mudge and has outperformed its pan European property benchmark in each of the last nine years, and its largest overweights are in comparatively buoyant sectors such as industrials, logistics and German residential. Continental Europe accounts for 60% of TRY’s portfolio. 

Broker Winterflood also favours TRY. It likes the growing yield and expects TRY to at least maintain the dividend this year “due to the diversified nature of underlying income and its significant revenue reserves”.

- Investment Trust Awards 2020: Best Private Equity and Growth Capital Trust

In the private equity sector, holdings are usually valued at a discount to established businesses in the same sector. So trusts’ NAVs are liable to fall in line with recent market movements, and may fall a lot faster if they or their holdings deploy a lot of gearing.

High gearing left the private equity sector in dire straits during the global financial crisis, as did the fact that many trusts had paid exorbitant prices for purchases in the run-up to the crash. There is therefore relief among brokers that most private equity trusts are much less geared or overcommitted to future investments than they were in the noughties, and that they have been more careful about overpaying for new holdings.

Equally, there are hopes that listed market comparables should not be too negative for the trusts’ NAVs, as a lot of  the PE trusts’ underlying holdings are in relatively defensive sectors such as technology, healthcare and consumer staples.

Myrto Charamis of Numis Investment Companies has modelled the potential impact of market movements on private equity trusts’ NAVs, taking into account their geographic and sectoral exposure. She likes HgCapital and Princess Private Equity, both of which are relatively highly rated, but also ICG Enterprise(ICGT), which has the highest discount in the fund of funds sector. She notes its strong track record, its exposure to relatively resilient sectors such as healthcare, software and packaging, and its board’s focus on balance sheet strength. 

Winterflood also believe ICGT’s discount looks excessively wide, not least because its defensive growth mantra is well established and its balance sheet should be able to cope with this year’s demands.

Charamis also favours Pantheon International, which adjusted its end-March NAV to take account of market movements in the first quarter of the year, whereas most other private equity trusts have made only minor adjustments to end-2019 valuations. Pantheon is very widely diversified, and has a low level of commitments relative to its financial resources and a conservative approach to valuations.

Stifel’s Ian Scouller also likes Pantheon on a share price of less than 2000p, given its net cash position and relatively low forward commitments. He also thinks NB Private Private Equity Partners looks good value now that it has increased it credit facility sufficiently to fund the potential redemption of its zero dividend preference shares maturing in 2022.

Last but not least, we think the sterling-denominated shares of Pershing Square Holdings look interesting on a discount in the high 20s. The multi-billion dollar hedge fund suffered nasty falls in the first two years following its October 2014 IPO, but has picked up well since its 2017 adoption of a more “investment-centric” approach. Managed by New York-based billionaire founder Bill Ackmann, it is invested mainly in US large caps with predictable, growing free cash flows and formidable barriers to entry, but also “with opportunities for improvement”; its managers deploy a range of strategies to unlock long-term value. With all its holdings reportedly achieving strong earnings growth, its NAV per share soared 58% in dollar terms in 2019.

Ackmann considered liquidating the trust’s portfolio earlier this year, owing to worries about the coronavirus, but instead spent $27 million on a series of hedges in late February. He realised them for $2.1 billion between 13 and 23 March, and invested 80% of the proceeds back into the market, mostly topping up existing holdings but also taking a sizeable stake in Howard Hughes.

His approach is not for the fainthearted, but it can be very successful – and it is encouraging that he and his colleagues own more than 22% of PSH’s outstanding equity, so their interests are aligned with other those of shareholders.   

Discounts outstripping 12-month average

Figures derived from data supplied by Numis Securiteis, as at end 7 May 2020.