We explain how to find a trust bargain and name three double-digit discounts that look too good to be true.
Investing in shares or sectors of the market that are ‘cheap’ and undervalued is an approach that entails many risks, but potentially offers great rewards.
The danger when it comes to shares with cheap price tags is the risk of catching the proverbial falling knife.
In the case of investment trusts, the same is true when sizing up discounts. A discount is when an investment trust’s share price is lower than the value of its underlying assets (its net asset value). For those who want to learn more about investment trusts, check out our guide.
Trading on a discount does not make a trust an instant bargain. Some trusts will justifiably be trading on a wide discount that could remain static or widen further. For example, a trust that has persistently poor performance and a small amount of assets (less than £100 million) is an unlikely candidate to be a potential bargain.
This is due to the fact that investment trust discounts transpire due to a lack of demand for the shares. This could be down to substandard short-term performance, as well as poor sentiment towards the region the trust invests in.
How to find an investment trust bargain
There are various ways to determine whether a discount looks cheap. A useful starting point is to assess the current discount relative to its historic average over different time periods, such as the past 12 months, three years and five years. This will indicate whether the current discount is wider than usual.
If it does look wider than usual, the next step is to compare the discount against the wider sector over different time periods. If the discount is wider than its rivals, this could be an attractive entry point.
Ultimately, though, investors need to have conviction that the discount is too good to be true and will in time narrow towards its net asset value (NAV).
Finally, it is worth bearing in mind that some investment trust boards attempt to control the discount/premium through buying back their own shares. In turn, this keeps the discount/premium within a tight range. Some trusts will buy their own shares at a certain level, such as a 5% or 10% discount. Eagle-eyed investors can take advantage of this, as the risk of the discount widening beyond a certain point is limited.
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Assessing investment trust bargains at the start of 2021
Substantial stock-market corrections offer brave investors the chance to go bargain-hunting, with the heavy sell-off in the first quarter of 2020 the most recent example. During the worst of the sell-off, the average investment trust discount figure exceeded its widest point since the global financial crisis over a decade ago, reaching 18.4% on 23 March. That compares with an average discount of 17.6% on 31 December 2008.
By the end of March, the average discount had tightened to 11.8%, which goes to show how rapidly discounts can change and how investors need to be alert to potential opportunities.
Discounts continued to recover from the end of March onwards. At the start of 2021, figures from Winterflood show the average discount is around 2%. Therefore, investment trust discount opportunities are thin on the ground.
Where to find trust bargains at the start of 2021
Two global-focused trusts catch the eye. The first is Brunner (LSE: BUT), which is trading on the widest discount of the trusts in its global sector. The discount stands at 17.6% versus its 12-month average of 11.8%, as at 11 January.
One factor behind the discount being wider than usual is that the trust had a fund manager change last year, with Lucy MacDonald stepping down. Appointed manager in 2005, Macdonald oversaw numerous changes at the trust. Chiefly, she saw through Brunner’s evolution from a UK-centric trust with more than 200 stocks to a much more concentrated and largely international portfolio with around 65 positions.
James Carthew, head of investment trusts at QuotedData, explains that there is another factor at play behind the current wide discount.
He says: “The trust hasn’t got the strong growth bias that has propelled many of the trusts in that sector higher in 2020. There is also no particularly high yield (around 2.3%) to attract investors.”
In addition, he also highlights the fairly recent manager change, which he says is “something that often unnerves investors”.
The trust has a 48-year track record of dividend growth, a key attraction that sets it apart from other global trusts. It favours high-quality growth companies, with Microsoft (NASDAQ:MSFT) and Roche (XETRA:RHO) among its top holdings.
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Anthony Stern, analyst at Stifel, notes the trust’s new manager Matthew Tillett was Macdonald’s former deputy. He says this provides continuity and described Tillett as a “safe pair of hands”. Stern argues the discount is more related to its sluggish performance of late.
He adds: “Its performance has lagged rivals in its sector over the past year. We believe the current discount is attractive relative to its history and other trusts in the sector.”
Henderson International Income (LSE: HINT), which is listed in the global equity income trust sector, is trading on a much smaller discount in comparison with Brunner, at 6.8%. But this catches the eye, due to it being wider than its 12-month average discount figure of 3.2%.
Calder explains: “Again, Henderson International Income’s performance suffers by comparison with other trusts in its global equity income sector that have adopted more growth-oriented styles. These either make up a portion of their dividend from capital or simply trade on lower yields than HINT. The trust has long traded at a premium (it even issued a large block of shares on 23 June). The discount opened up mid-July and hasn’t narrowed since. We cannot spot any trigger for this.”
The trust, managed by Ben Lofthouse, does not invest in the UK and has actively underweighted the strongly performing US market on valuation grounds since 2016. The latest figures at the end of November 2020 show the trust had just 33% in the US, compared with the MSCI World ex UK index weighting of 69%.
HINT targets a similar yield to UK equity income trusts. This makes it interesting for investors who already have exposure to UK equity income and want to avoid having too much home bias in their portfolios. It is yielding 4%, and pays income quarterly.
Outside global trusts there are other discount opportunities. Winterflood picks out Standard Life Private Equity (LSE: SLPE) as a candidate. The trust is held in the ii Active Growth and ii Active Income model portfolios.
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Winterflood points out that, in common with other private equity trusts ,SLPE had a roller coaster of a year, with its share price falling 40% at one point. However, it benefited from the market recovery that took place from the end of March onwards and ended the year in positive territory, up 20%.
“Despite this, the fund is currently trading on a 25% discount to its latest NAV. We believe this represents a significant value opportunity given the fund’s strong long-term performance record, the quality of its investment portfolio, which reflects the team’s well-established selection process, and the strength of its balance sheet,” says Winterflood.
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