How to capitalise on Christmas discounts

Are investment trusts on your shopping list for the post-Christmas sales this year? There are certainly some bargains to be had: shares in the average investment trust currently trade at a discount of more than 15% to the value of its assets. In other words, you can buy, say, £1,000 of investments for less than £850.

If that sounds too good to be true, there is a catch. Once you buy investment trust shares at a discount, you need that discount to narrow in order to benefit. There are no guarantees about when that might happen – if at all. Indeed, it’s also possible that the discount will widen, which could leave you worse off.

How, then, to best capitalise on the discounts this festive season? New research from the investment trust analyst Kepler aims to answer that question. It has run the slide rule over 20 years of data in an attempt to bring some science to the art of navigating the sales.

For example, you might think that the biggest discounts offer the greatest opportunities. But Kepler’s number-crunching suggests this isn’t the case – looking back, trusts on very wide discounts at a given moment haven’t tended to produce superior returns for investors over the subsequent one or three-year periods.

The widest discounts, Kepler speculates, may be indicate a serious structural issue or investment challenge at a fund; in which case, the shares may not be the bargain you might think.

Screening these funds out of the search therefore makes sense. And when Kepler looked only at investment trusts with moderate discounts – its cap was a maximum discount of 40% – the results were encouraging. Around 58% of these funds outperformed the stock market over the subsequent 12 months.

The winning funds – those in the 58% – shared more than just a moderately-wide discount, Kepler found. They also tended to be supported by an array of fundamentals – an experienced management team, for example, but also positive tailwinds from the broader market environment.

In other words, the key to success here is to find genuine pricing anomalies. You’re looking for investment trusts where the shares are trading at too wide a discount given the quality of the fund and its prospects for future returns. And you need to steer clear of funds trading at a discount that reflects inherent weaknesses and problems that may take some time to overcome.

In the former category, sectors of the market where sentiment has turned gloomy or anxious can often prove to be a happy hunting ground. Kepler picks out technology and private equity as two good examples.

In the tech sector, it says the wide discounts on some funds reflect a perception that soaring technology shares have become expensive; investment trusts here may represent an opportunity to get cheap exposure to stellar performers such as Microsoft and Nvidia.

In the private equity sector, meanwhile, sentiment has been depressed by a tough market for dealmaking, but this should ease now interest rates are coming down.

Other areas to explore, Kepler suggests, include Emerging Markets and Japan, particularly where investment trust boards are also taking proactive steps to bring discounts down. That could include share buybacks and other corporate actions, for example.

The bottom line is that investors need to focus on their attitude to risk and their long-term goals. That will determine where in the market they look for investment exposure. But if there is an opportunity to get extra value in those spaces, it makes sense to take advantage. Picking up an investment trust in the sales could be just that opportunity.