Why investment trusts on a premium can still be good value
David Prosser explains why expensive looking funds can be a good bet.
Shares in investment trusts always trade at a discount to the value of the fund’s underlying assets, right? No, actually. Even in today’s market, where discounts at many funds are higher than their historic averages, there are more than 20 investment trusts trading at a premium, according to a recent analysis published by the investment platform AJ Bell.
At first sight, it might seem counter-intuitive to consider any of these investment trusts for your portfolio. No-one wants to pay more for a collection of assets than they are actually worth. However, dig a little deeper and the stories underpinning investment trusts trading at a premium are often very interesting.
City of London Investment Trust – with a 418% total return over the past 20 years compared to 283% from the UK stock market as a whole – is just one example.
David Prosser
Moreover, it’s important to remember that premiums – just like discounts – are simply a function of an investment trust’s structure. Each trust’s shares are publicly listed on the London Stock Exchange, enabling investors to buy and sell exposure to the fund’s underlying assets whenever they choose (this liquidity is valuable). And sometimes, market demand for an investment trust’s shares gets out of sync with the value of those assets, so that they trade at a premium or a discount.
There is usually an explanation for this. In the case of trusts currently trading at a premium, AJ Bell divides them, broadly, into three groups.
First, it points out, a number of funds currently trading on a premium offer a real specialisation in income investment. Examples include Invesco Global Equity Income, Aberdeen Equity Income and TwentyFour Select Monthly Income.
Demand for these funds is elevated because investors expect central banks around the world to continue cutting interest rates, reducing the income on offer from asset classes such as cash and bonds.
By contrast, income-focused investment trusts offer access to dividends generated by their portfolio companies, as well as the potential for long-term growth. Investment trusts are also able to offer income “smoothing”, holding back some dividends in strong years to support payouts in weaker periods.
Against this backdrop, some investors may feel that paying a small premium for the strongest income-focused investment trusts is worthwhile; indeed, the premium should be regarded as a signal of the market’s confidence in the proposition they offer.
AJ Bell’s second group of premium rated investment trusts includes a number of funds it believes have the strongest credentials in terms of their long-term performance record. With market volatility having characterised so much of this year – and little sign of geopolitical tension and uncertainty dissipating – funds that have consistently demonstrated their ability to deliver solid returns currently feel like a safer bet. So much so that they attract premium valuations.
AJ Bell says City of London Investment Trust – with a 418% total return over the past 20 years compared to 283% from the UK stock market as a whole – is just one example.
Third, AJ Bell points to investment trusts that find themselves in an unusual place or a special situation. The most striking example here is JPMorgan Emerging Europe, Middle East & Africa, where the premium has been as high as 310% in recent weeks. The reason for that is this trust holds significant investments in Russia, which it currently values at close to zero given the economic sanctions imposed on the country following its invasion of Ukraine.
In effect, the premium suggests that investors hope to get a significant boost as and when the Ukraine conflict finally comes to an end and relationships with Russia become more normal. Knowing when (or even if) that might eventually happen is tricky – but you can see the theoretical opportunity here.
Another example of a special situation is 3i Group, the giant venture capital investment trust. It has a large holding in the privately-owned Dutch discount retailer Action, AJ Bell points out; the company is regarded by some investors as the next Amazon – in which case it may be worth paying a premium for 3i shares to get in on its growth at an early stage.
None of which is to suggest these funds – or any of the other premium priced investment trusts – are appropriate for all investors. Rather, the point here is that investors should not automatically be put off by premiums. They may signify an exciting opportunity worth exploring. At the very least, a premium is often evidence of broad market regard for the fund.
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.
