‘Investment trusts are in a battle to stay relevant’
A report by investment trust analyst Deutsche Numis says the sector is being impacted by various headwinds.
30th July 2024 11:03
by Kyle Caldwell from interactive investor
The rise in investment trust consolidation, a topic we recently covered, is a trend that’s here to stay due to the impact on the sector of various headwinds, according to investment trust analyst Deutsche Numis.
In a report published yesterday, Deutsche Numis said headwinds the investment trust sector is facing include “retrenchment by retail investors, outflows from multi-asset funds and the rise of tracker funds”.
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The analyst also named rising bond yields as another headwind, which has reduced demand for alternative investment trusts that pay an income, particularly those specialising in infrastructure or renewable energy infrastructure.
While the yields are typically higher for those investment trusts, investors have been focusing on lower-risk areas where yields have risen. For example, cash-like money market funds are offering yields of around 5%.
The final headwind cited by Deutsche Numis are cost disclosure rules, which make some investment trusts look less attractive in terms of how their charges are calculated and presented.
Combined, the headwinds are contributing to falling demand for investment trusts, which is causing discounts to reach wide levels. Overall, the average discount, excluding 3i Group which is on a big premium, is around -14%.
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Deutsche Numis says: “Investment trusts are in a battle to stay relevant in the face of a lack of demand from many traditional buyers and fixed income offering yields that offer a credible alternative to ‘alternatives’”.
It adds: “More capital was returned than raised in the first half of 2024, continuing the trend that started in 2023, after over a decade of annual net inflows, stretching back to at least 2010, when we started keeping records. In the first half, just £430 million was raised versus £5.2 billion returned, leading to a net outflow of £4.87 billion.”
So far, 2024 is a record year for investment trust mergers. The proposed mega-merger of Alliance Trust (LSE:ATST) and Witan (LSE:WTAN) could create an investment trust big enough for inclusion in the FTSE 100.
In addition, some investment trusts could wind up, including embattled property portfolio Home REIT whose shares have been suspended for the past 19 months.
Ultimately, consolidation is picking up is because there are a lot of potentially sub-scale investment trusts. For a wealth manager to consider an investment trust, the assets need to be around 300 million for it to have a sufficient amount of liquidity.
Of course, retail investors can consider investment trusts with assets below £300 million, and some are potentially hidden gems. But do bear in mind that some small investment trusts have higher costs, including potentially higher dealing spreads.
In the past, investment trust boards have come in for criticism over their reluctance to engage in potential mergers with the thinking being that turkeys don’t vote for Christmas.
However, it is positive for shareholders that investment trust boards are being proactive, and there has been a notable uptick in share buybacks in an attempt to tackle wide discounts.
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Ultimately, the bigger an investment trust, the greater the chance of higher demand due to the likelihood of it being on the radar of both retail investors and wealth managers.
Numis says: “Overall, we expect the period of consolidation to continue, resulting in a smaller, leaner investment trust universe, with the strongest investment trusts surviving.
“We believe this is a healthy process for the sector and we also expect there to be plenty of opportunities for investors to benefit from buying undervalued assets in investment trusts, where structural changes might help to crystallise some of the value.”
It adds “for the sector to flourish again, retail investors need to return to risk assets”.
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