Ian Cowie: plenty for value-seekers among smaller funds

Our columnist puts a spotlight on the smaller investment companies sector where discounts are massive and consolidation seems inevitable, but where some face an uncertain future. 

Small investment trusts’ shares often trade at a big discount to their net asset value (NAV), offering opportunities for brave buyers to make substantial gains if these double-digit discounts narrow to nearer NAV. Now, a leading analyst claims the sector is ripe for consolidation, following the coronavirus crisis, in much the same way that the number of investment trusts shrank after the global financial crisis in 2008.

Here and now, while independent statisticians at Morningstar calculate that the average investment trust share trades just 3% below its NAV, the average discount is seven times bigger for smaller funds. New research by the stockbroker Numis Securities shows that for trusts below £200 million in size the average discount is more than 20%. For funds below £50 million in size, the average discount is nearly 25%.

So there is plenty for value-seekers to play for, bearing in mind that 185 investment trusts have a stock market capitalisation - that is, the total value of all their shares in issue - of less than £200 million and that this sector represents about half of all investment trusts by number. 

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Senior Numis analyst Ewan Lovett-Turner said: “There are too many investment companies that are sub-scale, trading on wide discounts and should wind-up or merge.

“The consolidation of wealth managers, the Woodford scandal and MIFIDII have increased the focus on liquidity and costs, meaning that a large portion of the universe is not investible to many of the core buyers. The tide may be turning with key stakeholders becoming more engaged, and a clear-up of small investment companies is underway after several boards recommended voting against continuation.”

Because of investment trusts’ closed-end structure, these pooled funds are often described as a form of ‘permanent capital’ and many have survived for more than a century. But it is a mistake to imagine that most are bound to survive for long.

Out of 326 funds launched between 2000 and 2009, some 254 no longer exist. That is an attrition rate of 78% and another 11 trusts (or 3% of the total) have adopted a realisation strategy, while seven trusts (2% of the total) have merged with another fund. This means that only 54 trusts (or 16%) of investment trusts launched over the last decade survived to see out their second decade.

Tiddlers tend to suffer higher percentage charges - because they have a smaller base over which to spread fixed costs - and lower demand because many institutional investors shun funds smaller than £200 million in total asset size. Against all that, even a small fund can pay for a decent lunch for its directors several times a year and turkeys rarely vote for Christmas.

Lovett-Turner pointed out: “Directors are often seen as a barrier to corporate action, and they should be more open to radical change, even if it means voting themselves - temporarily - out of a job.

“Increased shareholder engagement is likely to be the most effective way to drive action.”

City cynics may snigger, but several boards of directors have switched fund management groups recently. These include Edinburgh Investment Trust (LSE:EDIN) (stock market ticker: EDIN) from Invesco to Majedie; Baillie Gifford European Growth (LSE:BGEU) (BGEU) from Edinburgh Partners to Baillie Gifford; and Baillie Gifford UK Growth (LSE:BGUK) from Schroders to Baillie Gifford.

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There is a clear trend away from underperforming value-focused managers shifting toward a capital growth approach. Contrarians may fear this marks the nadir or low-water mark for value and the peak or high-water mark for growth.

More controversially, shareholders will soon vote at European Opportunities Trust (LSE:JEO), which suffered from exposure to fraud in Wirecard, and at Riverstone Energy (LSE:RSE), which experienced poor performance after oil and gas prices collapsed.

Numis also identified several other relatively small trusts trading at discounts which might attract attention aimed to raise share prices nearer to NAV.

Funds “facing an uncertain future” include:

•  Jupiter UK Growth (LSE:JUKG) with a £28 million market cap, 6% discount, it appointed high-profile manager, Richard Buxton, but it is hard to see it growing from such a low base.
• BlackRock Income (LSE:BRIG), market cap £37 million, 7% discount, sub-scale in the UK Equity Income sector which includes other large more liquid trusts.
• ScotGems (LSE:SGEM) £40 million market cap, 15% discount, sub-scale and large management group shareholders.
• Jupiter Green (LSE:JGC) £34 million in size, 12% discount, small despite offering exposure to an in-vogue asset class.

Big isn’t always best but, below a certain size, diseconomies of scale can reduce demand and efficiency. After all, the purpose of an investment trust is to generate income or growth - or a mixture of both - for its shareholders; it is not to provide an agreeable luncheon club for its directors.

Ian Cowie does not own shares in any of the investment trusts mentioned in this article.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

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