Buy investment trusts now before the big discounts disappear (2024)

Shareholders in investment trusts enter the new year in much better spirits than seemed likely in the autumn, after an extended period during which discounts (the gap between a trust’s share price and the value of its assets) rose relentlessly to their widest level since the global financial crisis.

The return of the 190-odd trusts in the FTSE All-Share investment trust index was a sobering -26pc (in share price terms) over the 22 months from January 2022 to the end of October 2023. Wider discounts accounted for the greater part of those losses.

When we include dividends the losses were more tolerable, but it was still an uncomfortable period for a sector that prides itself on its superior longer-term performance relative to other types of actively managed fund.

Fortunately the past three months have seen a reversal of fortunes: asset values have risen and discounts have started to narrow, adding further capital appreciation.

The average discount across the entire trust universe of 330 names has come in from a peak of 19pc to 15pc now and the investment trust index, which measures the performance of most of the larger and more widely held listed funds, has returned just short of 9pc, 3 percentage points ahead of the FTSE All-Share index, over the past three months.

That is encouraging, although discounts remain notably wide by historical standards; the average figure four years ago was just 3pc (admittedly that was itself an abnormally narrow number).

The big question for any investment trust shareholder today is whether – and if so how quickly – we will witness a return to a more normal pattern of pricing. A secondary question is how best to exploit any future improvement in valuations that does materialise.

There are some genuine positives. The most important is the growing evidence that interest rates have peaked and will start to come down over the course of this year as inflationary pressures ease.

In the absence of a serious global recession, which certainly cannot be ruled out, that will generally be positive for most types of asset and especially for so-called alternative assets, such as private equity, commercial property, infrastructure and renewable energy, all of which can be invested in via investment trusts.

Trusts of these types, which tend to be bought for their capacity to deliver attractive and secure above-inflation dividend yields, are particularly sensitive to changes in the cost of money, so any improvement in the interest rate outlook will clearly benefit them, just as rising interest rates penalised them in the 20-month period described earlier.

Two other factors are encouraging too. One is a long overdue decision by the Government, in tandem with the Financial Conduct Authority, to promise reforms to the rules that govern how investment trusts measure and report the cost of ownership to shareholders.

This seemingly arcane issue has undoubtedly contributed to the recent widening of discounts and its resolution should in due course help bring back some additional demand for investment trust shares from institutional investors.

The third positive factor is evidence that the boards of investment trusts, which are legally responsible for looking after the interests of shareholders, are starting to wake up and take more decisive action to address the losses that wider discounts have produced. The arrival of activist funds, such as America’s Saba Capital, on the registers of a number of well known trusts has undoubtedly helped to prod even the more complacent investment company directors to do something.

Share buybacks, mergers, debt refinancing and in extreme cases liquidation or sale of the trust are among the steps that boards can take to address a persistent discount. Selling or shutting up shop typically gives shareholders in a trust that trades on a wide discount an immediate gain.

Fourteen trusts have disappeared in this way over the past 12 months, producing decent share price increases for investors in most cases, while the broker JP Morgan Cazenove has estimated that up to 30 could follow them into oblivion in 2024 thanks to some combination of shareholder pressure and board action.

When it comes to investment options this year, one obvious tactic for readers therefore is to look for those trusts where there is good reason to believe that effective remedial action on the discount is likely to materialise. This could be particularly profitable in the case of trusts whose investment style or focus is already out of favour for other reasons, contributing to a period of poor performance.

Three of the larger trusts that feature among Saba Capital’s holdings, Edinburgh Worldwide (ticker EWI, discount 13pc), JP Morgan European Discovery (JEDT, discount 11pc) and BlackRock Smaller Companies (BRSC, discount 10pc), are examples. All three invest in smaller companies, very much an out-of-favour type of asset at present, albeit in different regions.

Another group of trusts to consider are those to have imminent continuation votes, which give shareholders the opportunity at regular intervals to vote on whether a trust should continue in business or hand back some or all of shareholders’ money, typically at close to net asset value.

JP Morgan Indian (JII) is a good example. In this case a new manager has recently been appointed to try to improve performance, offering a two-way bet on the outcome.

You could also research trusts, such as Next Energy Solar (NESF), that have publicly set firm discount control targets but have so far failed to meet them.

In the event that you do not feel qualified to find such situations yourself, an alternative is to buy shares in professionally managed trusts whose mandate is to seek out these discount opportunities for you. Three excellent trusts that do just that are AVI Global (AGT), Migo Opportunities (MIGO) and – in the property sector – TR Property (TRY).

For most investors, it should be said, it remains the case that the best medium to long-term results are likely to come not from such tactical manoeuvres but from initiating or adding to holdings in the highest-quality proven performers which are, for external reasons, currently trading at attractive discounts. Here are some of the best examples among many: in private equity Hg Capital (HGT) and ICG Enterprise (ICGT); in renewables Greencoat UK Wind (UKW); in shares Pershing Square Holdings (PSH), Smithson (SSON) and Henderson Smaller Companies (HSL); and among specialist trusts Polar Capital Technology and International Biotech (IBT).

The biggest headwind that all these trusts face remains the big-picture factors of interest rates, inflation and geopolitics.

Experience suggests that inflation is likely to remain stickier than many investors perhaps complacently assume, that a recession is by no means out of the question and that the ability of geopolitical tensions to disrupt oil prices and economic growth is a far from negligible risk.

Whatever your gung-ho broker may be telling you, a restoration of the fortunes of the investment trust sector presents some great opportunities, but it is going to take time to reap the benefit, so don’t expect overnight rewards.

Jonathan Davis is editor of the Money Makers investment trust newsletter (money-makers.co)