Is it time to bag an investment trust bargain?

2023 has been tough for investment trusts. In the first half of the year, the average investment company generated a return of just 0.3%*, and the average discount – when the share price of an investment trust is less than the net asset value (NAV) – widened to nearly 15%*.

While the data hides a lot of dispersion between sectors, the Association of Investment Companies (AIC) points out that you do need to go back to the global financial crisis in February 2009 to find discounts this extreme – a time when there were “dire profit warnings, grim GDP figures and governments competing with each other to bail out banks and support shell-shocked economies.” 

What has caused the discounts today?

Many investment company sectors are particularly sensitive to interest rates, which, as we know, have been rising rapidly as the UK and other developed markets have tried to tame high inflation.

These higher interest rates have pushed up the yields on bonds making them much more attractive. As a result, money has flowed from equities to fixed income. Growth assets have also suffered because their long-term discounted cash flow is reduced and their ability to secure low-cost debt financing is more difficult.

What next if interest rates have peaked?

With both the US and UK central banks having paused interest rate rises last month, there is now some hope that they have peaked.

If this is the case, investment trusts could get a boost. The AIC looked at three discount “troughs” – March 2003 (-12.8%) at the end of the tech bubble, February 2009 (-16.4%) in the global financial crisis and June 2016 (-11.9%) after the EU referendum**.

“The annualised returns of the average investment company in the three years following each trough were 34%, 22% and 9% respectively,” commented the AIC’s Nick Britton. “Clearly, some of the difference is explained by the fact that the first two troughs occurred towards the end of major bear markets, while the third came after the ‘leave’ vote in the EU referendum, which was hugely significant for the UK but less so for global markets.”

“Looking at which sectors performed best in these recoveries, it is all about growth,” continued Nick. “Smaller companies is a common theme, and especially UK smaller companies which outperformed the average investment company in all three periods. Global emerging markets and private equity also did well. For all these sectors, narrowing discounts provided an extra boost to returns.”

Current discount levels could, therefore, represent an attractive opportunity for long-term investors who may benefit from the double-whammy of improving NAV performance and tightening discounts when investor sentiment improves. 

Some multi-asset fund managers are certainly seeing the opportunity. Dr Niall O’Connor, manager of the SVS Brooks Macdonald Defensive Capital fund told us in June that investment trusts comprised up to 50% of the fund’s assets. His belief was that the price moves have been driven by flows more than fundamentals. “Investors have been flocking to the perceived safety of bonds as yields have risen,” he said. 

“We see this impact through ever-widening discounts to net asset values and we liken these magnitudes of discounts to holding a balloon underwater: they can persist, they could even widen further, but ultimately when released the rally in share price can be dramatic.”

James Yardley, senior research analyst at FundCalibre says: “You can’t rule out things getting worse before they get better, but in our view it’s a once-in-a-generation chance to buy investment trusts. It’s been an absolute wipeout with a huge amount of pain across the market.

“Everything has been taken down together but that means there are some incredible opportunities out there. The important thing to remember is that discounts aren’t something to be afraid of; it is the performance of a trust and the abilities of its manager which are likely to be the most significant contributors to success over time.”

Of course, a trust could be trading on a discount for numerous reasons, not just those mentioned above. For example, sentiment may just be weak on a trust – meaning investors think the asset value will go down. If an area is very unfashionable – as Japan has been for much of the past decade, or the UK is today – owners of shares wanting to sell will need to be prepared to offer their shares at a discounted price to attract potential buyers. However, poor sentiment is sometimes unwarranted, creating major opportunities for investors.

Discounts may also widen because of trust-specific problems, like a change in manager or a prolonged period of poor performance.

Ultimately, it’s always important to do your research. As a starting point, here are all the investment trusts that are rated by FundCalibre, and their current discount. 

The trust with the largest discount is Schroder British Opportunities, and co-manager Uzo Ekwue told us more about this in this recent podcast interview. 

We heard more from Praveen Kumar, manager of Baillie Gifford Shin Nippon, on why now could be the next phase of Japan’s growth story. 

*Source: AIC, July 2023, data from 1 January to 30 June 2023

**Source: AIC, September 2023

***Source: AIC, 10 October 2032

_{Image by Markéta Klimešová from Pixabay}