Investment trust premiums: when to buy and when to avoid

Most investment trusts are trading on discounts, but care still needs to be taken when sizing up those on expensive ratings. Faith Glasgow explains.

This year’s market turbulence, culminating in the vigorous response to the previous chancellor’s mini-budget in September, has hit investment trusts painfully.

The FTSE All Share Closed End Investment index is down around 20% year-to- date, compared with the FTSE All-Share, which has lost around 10%.

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According to the latest Winterflood monthly investment trust review, 79% of investment trusts were in negative territory for the year as of the end of September, and the average share price discount to net asset value (NAV) had slid to 14%, compared with just 2.1% at the end of 2021.

But while bargain hunters may now be eyeing the many high-quality funds currently sitting on rare and substantial discounts, it would be a mistake to assume that the entire closed-ended universe is now super-cheap. So where are the tight discounts and premiums lingering, and what’s underpinning them?

Top of the (pretty short) premium table at the moment is CQS New City High Yield (LSE:NCYF), which is on a 7.3% premium versus a one-year average premium of 5.6%, according to Numis data for 31 October. “A large part of the attraction is its yield – 8.3% currently,” observes James Carthew, head of investment companies at QuotedData.

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Additionally, the manager’s focus on capital preservation means it has also held up better than many of its peers in the AIC’s debt loans and bonds sector, with an NAV return of 0% over the past 12 months.

High yield, in this case a whopping 9.5%, also underpins the 2.8% premium on Henderson Far East Income (LSE:HFEL). Carthew adds a note of caution, however: “This yield comes at a price of poor performance relative to peers – while the dire state of the Chinese market has held back the region. It is notable that Henderson Far East Income is the only one of its Asian Income peer group to have made negative returns on NAV over the past five years.”

Another trust to be scrutinised closely is Chelverton UK Dividend Trust (LSE:SDV), currently trading on a premium of 5.1%. “It is overvalued we think – the sharp fall in its NAV (amplified by the gearing from its zero dividend preference shares) has not yet been reflected in its share price fall,” warns Carthew.

But other premiums are easier to justify. One standout candidate is the UK equity income “dividend hero” City of London (LSE:CTY), trading on a 2.4% premium and paying a 5 yield.

As Andrew McHattie, who publishes the Investment Trust Newsletter, explains: “The flight to quality and to the big-name ‘dividend hero’ trusts ensured strong ratings.”

It’s a similar story for Merchants Trust (LSE:MRCH), on a 1.2% premium and a 5.4% yield, and with a 39-year record of rising dividends.

Carthew agrees that “longevity probably appeals to investors in the current climate”.

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He points out that City of London is the leading dividend hero, having raised its dividend consistently through market booms and busts across 56 years. “In addition, on performance, its more conventional high-income UK value portfolio has done comparably well over the last 12 months,” he adds.

Unsurprisingly, risk aversion has also been driving demand to trusts in the flexible sector with a focus on capital preservation. “Capital Gearing (LSE:CGT) (2.1% premium), Ruffer Investment Company (LSE:RICA) (3.1% premium) and Personal Assets (LSE:PNL) Trust (1% premium) all fall into this category,” comments McHattie.

Bargain-hunting is itself already having an impact on some parts of the market too, it seems. Analyst Stifel points to some UK mid and small-cap specialists where, although discounts still prevail, they have been narrowing in recent days - likely a consequence of canny buyers bottom-trawling as the political scene shows signs of settling somewhat after its recent turbulence.

Turning to alternative assets, McHattie points to the energy storage sector as one that has “been able to keep the premiums fully charged”.

There’s little competition within this relatively new industry, and it’s crucial in facilitating the use of renewable energy sources that cannot be easily switched on or off. “This means these trusts are expected to generate relatively high and secure returns for investors,” says McHattie.

Additionally, battery storage is exempt from the government’s planned windfall tax on renewable energy generators.

The sector comprises three trusts, among which Gresham House Energy Storage (LSE:GRID) is trading on a 10.4% premium, and Gore Street Energy Storage Fund (LSE:GSF) on a 4.9% premium.