Kyle Caldwell highlights the areas analysts are finding value in, which includes a number of mainstream investment trusts that have outperformed over the past three years.
While the largest US technology stocks have experienced a reversal in fortunes over the past six months compared to 2022, the consensus among market commentators is that growth stocks will not have it all their own way over the next couple of years.
Instead, the professionals expect that it will be a tougher period for growth companies, given that we are in a new regime of higher interest rates, which are expected to peak at 6.5% in the UK next March. Schroders, the fund manager, thinks the peak could even happen by the end of this year.
In 2022, growth shares struggled due to rising interest rates, which boosted the income returns on lower-risk investments such as cash and government bonds. As a result of this, there’s less appeal in owning shares whose profits were expected a long way into the future.
In contrast, cheaper shares were boosted by rising commodity prices, with mining and oil key parts of a value investor’s hunting ground. Value stocks are cheaper than growth stocks, with valuations more reflective of current earnings rather than their future potential. Such companies also tend to have large dividend yields, which investors become more drawn to in uncertain times, given that income provides a tangible return.
Interest rate rises have triggered a re-pricing of all risk assets. With yields of between 4% and 5% available on cash and relatively low-risk bonds, there’s less appeal in trying to obtain bigger returns for greater risk. In response, investment trust discounts have widened. In addition, some investment trusts have seen their yields rise in response to share price falls.
Value can be found in mainstream sectors
As we explain below, investment trust analysts are finding potential opportunities among private equity and infrastructure, but there’s also a case for looking for value in more mainstream sectors.
As pointed out by Robert Murphy, managing director of investment trusts at Edison Group, there are well-known investment trusts with solid performance track records that are trading on wider-than-usual discounts.
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Murphy says: “The rising interest rate environment will be challenging to navigate, which for me calls for a more diversified approach rather than just owning a pile of growth stocks.”
Three global trusts picked out by Murphy, which have notably outperformed the sector average over three years and are trading on discounts wider than their 12-month averages, are Brunner (LSE:BUT), Alliance Trust (LSE:ATST) and Witan (LSE:WTAN). The trio, on a share price total return basis, have over that period outpaced the sector average return of 3.0%, which has been weighed down by a loss of 26.6% for Scottish Mortgage (LSE:SMT). The respective three-year returns, sourced from FE Fundinfo, are 35.5%, 33.3%, and 29.8%. The trio are in the top quartile (best 25% of performers) of the sector over that period.
Six mainstream investment trusts looking cheap
|Investment Trust||Current discount (%)||12-month average discount (%)|
|F&C Investment Trust||-10.6||-4.6|
|Ruffer Investment Company||-4.3||1.3 (premium)|
Discount figures sources from Numis on 12 July 2023.
Brunner invests in global shares, with around 40% in the US, 25% in the UK, 25% in Europe, and the remainder in Japan and Asia-Pacific excluding Japan. It offers investors less exposure to the US than other global funds, which typically have around 60% or more. It has 61 holdings.
The other three are multi-manager strategies, with a higher amount of holdings and greater levels of diversification. For this reason, Alliance Trust, Witan and F&C are considered potential one-stop shop options for beginner investors. The trio are consistent dividend payers, and are part of an eight-strong club of investment trusts that have increased their payouts for at least half a century.
We recently interviewed Alliance Trust's Craig Baker as part of our Insider Interview video series, which you can watch by clicking on the two links below.
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Two other mainstream investment trusts on wide discounts, despite having strong three-year numbers, operate at different ends of the risk spectrum. Pershing Square Holdings (LSE:PSH), managed by Bill Ackman, has just 10 stocks, while Ruffer Investment Company is one of a small number of wealth preservation investment trusts that offers defensive ballast.
Pershing Square Holdings’ share price total return is 53.2% over three years versus 37.6% for the North America sector average.
Investec Securities points out that over five years (to the end of May 2023) Pershing Square Holdings is ranked first out of 141 US funds and investment trusts. The return of the underlying investments – the net asset value (NAV) – was 229.1%, ahead of an average of 63.8% for the funds examined.
However, despite this strong performance, Investec notes the Ackman-managed portfolio “somewhat inexplicably in our view...continues to fly beneath the radar screen”. Investec analyst Alan Brierley puts this down to “misconceptions” about the way in which it invests. Ackman is the founder of activist hedge fund Pershing Square, but no longer carries out activist short selling.
Pershing Square Holdings’ current discount is 35.3%. Ackman is a value investor who looks for high-quality business with strong barriers to entry. He also puts hedging strategies in place to reduce risk or take advantage of opportunities. A recent trade that paid off handsomely was putting hedges in place when interest rates were low in the expectation that rates would rise significantly. As we now know, this has played out over the past 18 months or so.
Brierley adds: “At a time when actively managed US large-cap funds are continuing to struggle to beat the S&P Composite, we firmly believe that Pershing Square Holdings is a unique and compelling investment proposition, and that strong fundamentals are enhanced by the current rating,”
On the face of it, a 4.3% discount for Ruffer Investment Company (LSE:RICA) doesn’t seem like a massive bargain basement price. However, due to Ruffer proactively buying back its own shares to limit discount volatility, the small discount on offer now doesn’t happen too often.
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Kepler, the investment trust analyst, says the small discount “looks attractive”. It adds: “We view this discount as reflecting market assumptions that interest rates and inflation are at or near their peak in the US and UK, and the subsequent drop in demand for assets which can protect against inflation.
“We think this is a dangerous assumption, and should there be any resurgence of inflation, or a growing realisation that it is a persistent feature of our economies, alongside higher interest rates, then we could see the discount close.”
Over three years, Ruffer has outperformed its average flexible investment peer, up 18.5% versus 8.4%. However, over shorter time periods its performance has come off the boil, which could also reflect why its shares are now on a discount. Its two fund managers, Duncan MacInnes and Jasmine Yeo, bought 15,000 shares in the investment trust last week, which shows their interests are aligned with shareholders.
Value opportunities in alternative areas
Beyond mainstream investment trusts, the two sectors that analysts are finding plenty of value in are private equity and infrastructure.
Both sectors have been negatively impacted by rising interest rates, with investors concerned that valuations have not fallen enough to reflect rate rises.
Milosz Papst, an analyst at Edison, says that in the case of private equity “the mistrust in the valuations that some investors have are not necessarily justified”.
He points out that the “lower volatility of private equity valuations” compared to public markets reflects “the resilient sectors and companies” that investment trusts in this space focus on.
In a recent episode of our On The Money podcast, Andrew Bell, chief executive at Witan, explained why he thinks private equity trust discounts have been overdone, which may create some potential bargain opportunities. Bell holds Princess Private Equity (LSE:PEY), and a couple of months ago bought HarbourVest Global Private Equity (LSE:HVPE).
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Papst agrees that there are potential value opportunities. He says: “The current discounts, ranging from 15% to 40%, offer a decent downside cushion. Private equity trusts have a good track record of providing an uplift of realising value.”
The infrastructure sector, including renewable energy infrastructure, is also attracting attention as a value opportunity. Numis, the analyst, says that with current discounts averaging 20% and yields averaging 6.4%, this “offers an attractive entry point”.
The sector is out of favour due to rising discount rates – a measure used to calculate the present value of future cash flows. Those discount rates have increased due to interest rate rises over the past 18 months or so.
Numis notes that while further “rising discount rates cannot be ruled out and would be a detractor to NAVs taken in isolation”, the fund managers can take steps to limit the impact. In addition, the analyst says that infrastructure assets are positively correlated to inflation, which given the high inflation backdrop is a positive for both cash flows and returns.
It adds: “Therefore, we do not believe that NAVs will decline to the level that current share prices are implying. Median implied discount rates are circa 10% currently, notably higher than trough levels seen during the global financial crisis. Dividend yields across sub-sectors are competitive in our view and range between 6-8%, with healthy levels of dividend cover (sector median 1.3x).”
Its six favoured options for the sector are: International Public Partnerships (LSE:INPP), Bluefield Solar Income Fund (LSE:BSIF, Greencoat UK Wind (LSE:UKW), Aquila European Renewables (LSE:AERI), VH Global Sustainable Energy Opportunities (LSE:GSEO), and Cordiant Digital Infrastructure (LSE:CORD).
Elsewhere, Investec Securities has recently reiterated its buy recommendations for Pantheon Infrastructure (LSE:PINT)and Cordiant Digital Infrastructure.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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