6 minute read
INVESTMENT TRUST Going cheap: investment trusts trading on wider than normal discounts
Mid and small cap trusts are among the parts of the market offering bargains
This year’s market turmoil has caused many investment trusts to trade below their average discount to net asset value. It means investors can often buy £1 worth of assets for 90p or thereabouts.
A popular trading strategy is to find investment trusts on wider than normal discounts and buy them in the hope the discount narrows. The trick is to understand which trusts have become cheaper due to a one-off factor or whether something has shifted in the market which could keep them cheaper for longer.
MID CAP MAHEM
UK mid-caps fell out of favour with investors earlier this year on fears that inflation and a potential recession would hurt earnings for companies, particularly consumer-facing ones.
The FTSE 250 index of mid cap stocks has fallen by 18% in value year-to-date, significantly underperforming the FTSE 100 index of largecap stocks which have been propped up by lots of companies that benefit from higher inflation including oil producers.
Mercantile (MRC) and Schroder UK Mid Cap (SCP) fish for opportunities in the FTSE 250 index. Both have seen the discount to the value of their underlying assets widen to 15.5% from a 12-month average of 12.5% and 11.1% respectively, according to data from Winterflood.
So much potential bad news is now priced into mid cap stocks and we saw earlier in July that it doesn’t take much good news to prompt a big share price recovery. For example, Frasers (FRAS) soared by more than 20% on 21 July after saying everything was going well with its sports retailing business.
Mercantile’s portfolio includes stocks such as Watches of Switzerland (WOS) and Dunelm (DNLM), both of whom have recently issued positive news. The Schroder trust also invests in Dunelm as well as Telecom Plus (TEP) which in June 2022 reported record results.
SMALL CAP PAIN
Smaller company investment trusts have also seen wider discounts to net asset value, both in the UK and elsewhere in the world.
For example, Montanaro UK Smaller Companies’ (MTU) discount has doubled to 10% from a 12-month average of 5.1%. Abrdn Smaller Companies Income (ASCI) is now trading 21.2% below the value of its underlying assets versus a 14.5% one-year average discount.
Montanaro UK Smaller Companies
Net asset value (p) Share price (p)
200
150
100
50
0
2020 2021 2022
Chart: Shares magazine • Source: Refinitiv
The small cap space has been hammered by investors panicking at the market correction earlier this year, then open-ended small cap funds being hit by redemptions. When someone asks for their money back, open-ended funds must sell some holdings to raise cash, which is then handed back to the investor. Therefore, you’ve seen a double hit of selling among smaller companies.
Closed-ended investment trusts are impacted by what happens with open-ended funds because they often invest in the same stocks.
Making matters worse is the fact that small cap stocks are often illiquid, so selling pressures can pull down the share price by a significant amount.
Fundsmith-managed Smithson Investment Trust (SSON) says it invests in smaller companies, but its investments are more comparative in size to UK mid-caps. Smithson’s shares have typically traded at a premium to the value of its assets since launch in 2018 yet this year they’ve plunged to a discount of 7.5%.
That can be explained by some of its stocks having traded on premium ratings and investors this year being less willing to pay a high price to own growth stocks, so elements of Smithson’s portfolio have suffered a derating which in turn has seen the share price fall.
A good illustration is portfolio company Verisk Analytics (VRSK:NASDAQ), which was trading on more than 50 times earnings in late 2021 and which has now derated to just under 30 times earnings. Its share price is down 17% year-to-date.
PRIVATE EQUITY MARKDOWNS
Private equity trusts have recently been in the spotlight as investors speculated the value of their unquoted assets would have to be marked down.
These types of investment trusts typically trade on a discount to the value of their assets to reflect the illiquid nature of their holdings – i.e. they can’t quickly sell investments. Yet discounts have certainly widened this year, particularly for companies with holdings in the broader technology space.
Chrysalis Investments (CHRY) was the talk of the town last year with its large stake in buy now, pay later group Klarna. This year Klarna’s valuation has dropped significantly, causing Chrysalis’ share price to dive, and its discount to net asset value to widen.
Investors have speculated that some of its other holdings will need their valuations written down. Some shareholders have even given up, with orders to sell their shares forcing down the value of the trust as buyers have been thin.
The effect on Chrysalis has been remarkable. Having seen a 12-month average discount to net asset value of 14.8%, the shares now trade at a 53.8% discount. That suggests investors have little faith in the stated value of its assets.
Also noteworthy in the private equity space is HgCapital Trust (HGT) which is now trading at a 20.7% discount versus a 12-month average of 4.1%. This trust invests in private companies in the software and business services sector in Europe and North America. It also looks to have been caught up in the negative market sentiment towards unquoted technology investments.
Verisk Analytics
PE ratio
50
2010 2012 2014 2016 2018 2020 2022
Chart: Shares magazine • Source: Refinitiv
Chrysalis Investments
200
100
0
2019 2020 2021 2022
Chart: Shares magazine • Source: Refinitiv
LOOKING FOR BARGAINS
Ironically, for a vehicle which seeks to take advantage of market inefficiencies in investment trusts, MIGO Opportunities Trust (MIGO) has seen a widening of its discount to 5.1% versus a
Examples of investment trusts trading on wider than normal discounts to net asset value
TRUST SECTOR 12-MONTH AVERAGE DISCOUNT LATEST DISCOUNT
Scottish Mortgage Global Diverse Income Trust UK Equity Income −1.7% −4.8%
−0.6% −3.2%
Mercantile UK Mid Cap −12.5% −15.5% Schroder UK Mid Cap UK Mid Cap −11.1% −15.5% Abrdn Smaller Cos Income UK Smaller Cos −14.5% −21.2% European Opportunities Europe Baillie Gifford US Growth North America −12.2% −16.3%
−5.3% −13.4%
Baillie Gifford Japan Japan
−1.9% −6.8% Jupiter Green Environmental −8.9% −20.1% Allianz Technology Technology −8.0% −12.5%
Table: Shares magazine • Source: Winterflood, 21 July 2022
12-month average of 0.8%.
In April, research group Kepler said MIGO’s discount had averaged 1.2% over the previous five years. Trusts in its portfolio tend to trade on much larger discounts.
‘When we met up with (co-manager) Nick Greenwood recently, he commented that with the average discount of the top 12 holdings approaching c. 25%, discounts have rarely been wider,’ added Kepler.
MIGO’s biggest holding is investment trust
VinaCapital Vietnam Opportunity Fund (VOF)
which at the time of writing was trading on an 18.8% discount. Recent additions to MIGO’s portfolio include Amedeo Air Four Plus (AA4), currently on a 53.2% discount to the value of its assets.
‘Demand for air travel has increased at a time when both Airbus and Boeing have faced challenges in delivering new wide-bodied planes. The Amedeo trust leases A380 planes to Emirates. Not only are many of them now back in service, they may well be needed for many years as their intended replacements are unlikely to be delivered by the manufacturers for some time,’ said MIGO.
DISCLAIMER: The author owns shares in Smithson.
By Daniel Coatsworth Editor
