Interactive Investor

Best value opportunities at the start of a new tax year

Faith Glasgow looks to find the best value opportunities for early bird ISA investors seeking to make the most of their new allowance at the start of the tax year.

8th April 2024 09:45

by Faith Glasgow from interactive investor

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'Value' spelled out in cubes 600

Global equity markets appear to have enjoyed a strong recovery since the start of last year.

But closer examination reveals just how diverse the fortunes of different parts of the market have been: while the giant US tech companies have powered ahead once more, valuations in many other areas remain historically low.

So, the big question for canny investors considering how best to use their 2024-25 ISA allowance at the start of the new tax year is where to find the best opportunities – in equity markets, but also in alternative assets – to buy robust but unloved investments with a good chance of recovery in the coming months.

UK shares on big discount to global shares

There are several obvious candidates for value-focused equity investors to investigate – one being the UK market itself, currently trading at a discount of more than 40% to global equities compared with the long-term average discount of 17%, according to Redwheel Asset Management.

As Darius McDermott, managing director of fund research agency FundCalibre, points out: “That’s despite the fact that 70% of FTSE earnings are derived from overseas.”

Not only is the UK cheap, but its dividend credentials are impressive. This is a huge attraction for income investors; but reinvested dividends also provide useful compounding compensation for growth investors until sentiment improves.

Gavin Haynes, investment consultant at Fairview Investing, likes Temple Bar Ord (LSE:TMPL) investment trust for exposure to dividend stocks. “Managers Ian Lance and Nick Purves at Redwheel took over managing the trust in 2020 and have produced impressive performance following a value-based approach. It currently yields 4.1%, in line with savings account returns,” he explains.

McDermott picks out a couple of more growth-oriented open-ended funds. He suggests: “If you’re seeking a value manager with a long-term track record, consider the ES R&M UK Recovery fund.”

Look beyond the FTSE 100 to find more value

Alternatively, the Liontrust Special Situations fund invests across companies of all sizes, and can therefore tap into the even more undervalued pickings available among high-quality mid and small-cap companies.

“The FTSE mid-cap index is currently on a price-to-earnings (P/E) ratio of 10.8 times, versus a long-term average of 13.9 times,” McDermott points out.

He adds: “A rebound could be sharp, but there remain a lot of challenges, including an uncertain inflation outlook and plenty of geopolitical challenges.” However, he believes global investors are likely to return to the UK as domestic economic data picks up.

The very cheapest stocks are found at the lower, more volatile end of the equity market cap range. Companies worth less than £250 million are trading at an average P/E ratio of just 9.3 times, according to fund firm Amati.

Moreover, says Andrew McHattie, publisher of the monthly Investment Trust Newsletter, “the value opportunity exists in several layers” among closed-ended funds in this part of the market, with “a further discount on UK smaller company investment trusts” as the cherry on top of broader UK and smaller-cap markdowns.

He picks Aberforth Smaller Companies Ord (LSE:ASL) trust, on a -12% discount in early April: “The managers argue that their value style has historically helped performance and is re-emerging as a benefit now.”

David Holder, senior research analyst at investment consultancy Square Mile, likes abrdn UK Smaller Companies Growth Ord (LSE:AUSC) trust’s focus on higher-quality and faster-growing UK small caps. “It also yields 2.5%, and the yield has grown by 9.5% annualised over the past five years, according to the AIC,” he notes. It is trading on a discount of -13.7%.

What could create the all-important catalyst for a turnaround in sentiment towards the UK? While economic recovery is crucial, especially for smaller caps, Holder says a change of government could also provide some impetus.

“Mergers and acquisitions, especially from overseas and private buyers, are highlighting the value on offer in UK plc, as does the scale of share buybacks,” he adds. Both activities are generally expected to pick up further in coming months.

The Bund, Shanghai, China

China’s cheapness stands out for

The other ultra-cheap regional market worth considering is China. There, economic and geopolitical concerns, from rising authoritarianism to a stagnant property market and slowing growth, have dented investors’ confidence.

“Most funds in the sector are down more than 50% over the last three years,” comments McDermott. “China is currently trading on a forward P/E ratio of 8.9 times, which is well below the average of 11.7 times.”

However, he takes the view that now could be a good entry point for long-term investors. The Chinese economy has seen some normalisation after pent-up demand for goods and services started filtering through to the economy last year, and targeted government stimulus is also helping.

“China remains a high-risk area, but there is potential for rich rewards for those with a long-term mindset,” he says. His choice to access that potential is the FSSA Greater China Growth fund.

Haynes agrees. “It does feel as though a very negative outlook is already priced in, and there is a significant margin of safety in owning a basket of well-financed and well-managed Chinese companies that have been indiscriminately sold off,” he observes.

His choices are both investment trusts. As a focused choice, Fidelity China Special Situations (LSE:FCSS) (also liked by McDermott) invests in “out of favour, misplaced companies”, and was trading at a -9% discount in early April.

Alternatively, says Haynes, “a broader Asia fund that takes a value approach, such as Fidelity Asia Pacific Opportunities, can provide exposure to China alongside other out-of-favour areas of Asian stock markets”.

Alternative assets harmed by rate rises

Beyond unloved regional equity markets, there have also been painful sell-offs in many investment trust sectors focusing on alternative assets, including renewable energy, infrastructure and private equity.

The recent rising interest rate environment crippled assets heavily dependent on borrowing. It also seriously impacted trusts investing in long duration and higher-yielding assets, as investors realised that fixed interest investments yielded almost as much income but involved less risk.

Square Mile’s Holder adds: “Given the proliferation of these types of assets within the closed-ended universe, the average investment trust discount has moved out aggressively over recent years, with many sectors seeing the double whammy of weaker NAV performance plus their discounts to NAV moving substitutionally wider.”

Nonetheless, says McHattie: “For investors who want to back an improving economic outlook, there could well be some bargains to be had.” He sees good opportunities among the chunky discounts in the mainstream global infrastructure sector, picking out BBGI Global Infrastructure Ord (LSE:BBGI) on a discount -10.8% and yielding 6.5%.

“The trusts dividend and NAV has grown every year since launch, and the trust has delivered 8.8% annual total returns since inception, so it should be a reliable performer,” he suggests.

Private equity - investment into unquoted companies – is also widely unloved, with concern over the validity of published net asset values still in evidence.

Some of the very wide discounts in the private equity sector are excessive, McHattie believes, singling out HarbourVest Global Private Equity Ord (LSE:HVPE) as a prime example. 

“The trust has an excellent track record, and over 10 years to end 2023 delivered NAV per share growth of 261%; the FTSE All World Total Return Index was up just 127% over the same period,” he says. 

“At the last reporting date its asset value was at a record high; yet the shares are languishing on a discount of around 40%, just about the widest in its peer group and with considerable scope to narrow.”

To explore more about whether alternative assets are potential a good entry point or a potential value trap check out our recent On The Money podcast, which covered the topic.

Why early bird ISA investing makes sense

Clearly, extreme mis-pricings are still readily available in many parts of the investment universe – making the argument for ‘early bird’ ISA investing particularly compelling this year.

If you’re in a position to put a lump sum into well-managed, robust but currently very cheap investments then your money will be working for you, producing dividends and with the potential for capital growth through the whole tax year.

As Haynes observes: “Trying to second-guess short term market movements is a thankless task, and the old ‘time over timing’ mantra means it really makes sense to maximise the time your money’s invested by getting in early in the year.”

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.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.

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