Can you find your ideal investment trust at a bargain price?
David Prosser on the potential merits of investment trusts trading at a discount.
Who doesn’t like a bargain? One attraction of the investment trust sector is that the way trusts are structured can sometimes throw up opportunities to make an investment on the cheap. That can help to supercharge your returns.
The principle to grasp here is that investment trusts work by issuing shares that offer exposure to their portfolios of underlying assets. Those shares are listed on the stock market, so it’s easy to buy and sell shares in the trust, whatever is happening in the portfolio itself. But the price of the shares depends on demand and supply; sometimes this gets out of kilter with the value of the trust’s assets.
When a trust’s share price undervalues its assets, the fund trades at a discount; effectively, you’re being invited to buy exposure to a pool of investments at a bargain price. If and when this anomaly resolves, you’ll make money, over and above what you have made from any increase in the value of the trust’s investments.
Sometimes, market sentiment can drive whole investment trust sectors to bargain-basement prices. And analysis published in recent days by the analyst Trustnet identifies three areas of the market where this may currently be going on.
If an investment trust meets your broader criteria, so much the better if you can buy its shares on the cheap.
David Prosser
Trustnet’s research compared investment trusts’ current discounts to the average discounts on which they have traded over the past five years, in order to identify areas where funds are currently priced more cheaply than has typically been the case in recent times.
Property was one area that stood out, including trusts with investments in UK residential assets, European property, and property-related debt securities. Trustnet also pointed to the Renewable Energy sector as a source of unusually high investment trust discounts, with Infrastructure trusts also looking atypically cheap right now.
It’s important to recognise there may be good reasons why a trust – or even a group of trusts – stands on an unusually large discount. Equally, however, discounts may reflect a market view you do not share. One reason for the cheap valuations in the Renewable Energy and Infrastructure sectors is that many investors expect interest rates to rise in the coming months; this has a direct impact on these funds. But not everyone agrees rates will rise – let alone by how much.
Investors don’t have to focus on entire sectors – you can also go looking for individual investment trusts where discounts appear to offer particular value.
A recent interview with Emma Bird, head of investment trust research at Winterflood, hosted on the Interactive Investor website, offers several examples. She picked out funds including HgCapital Trust and The European Smaller Companies Trust as looking unusually cheap at current valuations. Sometimes, Bird points out, funds even have discount control mechanisms that automatically kick in to try to bring discounts down when the valuation reaches a certain point.
None of which is to suggest that an investment trust is a slam dunk simply because it’s trading on a wider discount than usual. But analysing funds in this manner can be a good starting point for investors looking for new opportunities; it could be a way to build a shortlist of potential investment trusts to investigate further.
All the usual caveats about taking a long-term view apply – there’s no knowing how long a pricing anomaly will take to correct, and you need to be comfortable investing in a fund on its own merits, rather than because you think you’ve spotted a bargain. Still, if an investment trust meets your broader criteria, so much the better if you can buy its shares on the cheap.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
