Desirable discounts?

Faith Glasgow goes shopping for investment company bargains

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Last year was a difficult year for most of us, but investment companies rode the market storms pretty well.

The sector started 2020 with share prices trading at an average discount to net asset value (NAV) of less than -2%; despite a dramatic widening of discounts to more than 20% when markets crashed in mid March, they recovered to end the year more or less as they had started it. Winterflood shows the current average investment company discount at just -3.6%.1

In other words, attractive opportunities priced substantially below the value of their underlying assets are not easy to come by at present. Equity-focused investment trusts in particular are providing thin pickings for bargain-hunters. However, it’s possible to find a few offering decent value.

 Andrew McHattie of the McHattie Group, which publishes investment trust newsletters, highlights Templeton Emerging Markets (TEMIT), the oldest emerging markets trust and second largest in its sector.

TEMIT beats the NAV performance average for the emerging markets sector over all timeframes and tops the table over five years. Yet it is presently sitting on a -10.7% discount to NAV, slightly wider than its 52-week average. In contrast, the current average discount for the emerging market sector is well below its 52-week average, reflecting the recent resurgence of investor interest.

“I dont think its discount reflects either its record, its status and liquidity, or the money flows into emerging markets at the start of 2021,” McHattie comments.  

Broker Stifel takes a similar view, upgrading its view of TEMIT to positive. “Since management changes in 2018, the fund has performed strongly. We are now more comfortable with the team and the fund offers value on a 10.7% discount,” says Stifel analyst Anthony Stern.2

For income-seekers, Stern points out in a recent note3 that Asia offers better prospects than the UK, not least because Asian economies have recovered so much faster from the effects of the Covid-19 pandemic.

He likes Aberdeen Asian Income (AAIF) as a mispriced choice – particularly compared to its peer Henderson Far East Income. HFEL made no NAV gains in the last 12 months and has consistently trailed the sector over recent years, but trades on a 2.5% premium, supported by its “chunky” 6.9% yield.

In contrast, AAIF yields 4% and saw 12-month NAV growth of 18%.  Yet it sits on an -11% discount and is trading at the bottom end of its discount range; moreover, Stern adds, “the board has been buying back stock as it looks to narrow the discount to the 5% target level, suggesting there is the potential for discount narrowing”.

Much less high-profile is the global smaller companies trust ScotGems (SGEM). It had a grim 2020, has net assets of just £48 million and currently sits on a discount of -18.2%. Andrew McHattie believes it offers some speculative value” as a potential target for takeover or other intervention, which could boost the share price and narrow the discount.

“Buying underperforming trusts on wide discounts in the expectation of corporate action can be a mugs game, as years can pass without anything changing, but we would have to say that ScotGems looks like a strong candidate for intervention,” he says.

Away from mainstream equity trusts, there are more opportunities to find big discounts. Both McHattie and Kepler have been eyeing Tetragon Financial Group (TFG) in the flexible sector, which McHattie describes as “perhaps the greatest bargain of them all” as the discount has widened to 60%.

Asset value fell by 1.3% and the dividend was cut in 2020. But, says McHattie: “Thats no disaster, and we do find it very difficult to square with the further widening of the discount. On a yield of 4.2% we think that holders are being paid to wait, and an improvement in the rating is likely from here, particularly if the dividend cut is reversed.”

However, Kepler warns: “TFG is currently pursuing legal action against Ripple, a constituent holding of its portfolio. We fear this may drag on, and think it is unrealistic to see a significant discount narrowing until the action is resolved.”

Footnotes:

Winterflood investment trusts daily research note, 25 January 2021. All data as at 25 Jan.
Stifel note, “Macro tailwinds & more reasonable valuations”, 20 January 2021
Stifel, “Looking for Income, Look to Asia”, 16 September 2020 and confirmed by phone 26.1.21 that view still holds.