There are high hopes that last year’s savage de-rating of investment companies will begin to unwind in 2024, but Deutsche Numis poured cold water on the idea that more optimistic stock markets would be the cause, stating it was retail investors who would be the driver.

Writing in a note about opportunities for the coming year the investment company analysts at Numis said that while share price discounts in the sector narrowed in the last two months of the year from the extreme levels of 20% in October, a widespread re-rating rested in the hands of private investors.

‘Retail investors have become an increasing portion of many shareholder registers in recent years and therefore it has been disappointing to see demand evaporate in the times of stress during Covid and around the [2022] mini budget,’ wrote Ewan Lovett-Turner, head of investment company research at the broker.

Lovett-Turner said that along with bearish sentiment at the stock market impact of surging interest rates, investors had less money to deploy as a result of inflation and the cost-of-living crisis caused and what cash they did have was put in increasingly attractive savings accounts.

‘A rejuvenation of demand from retail investors is likely to be required to see substantially narrower discounts,’ the head of research said.

However, those investors looking to put money to work have plenty of options in investment companies, the Numis team said, highlighting bargains in eight out-of-favour areas of the market.

Growth capital

Growth investing was firmly out of favour in 2023, but the tide is turning and while the style itself is not likely to be sought out by investors, Numis anticipates that investment returns will shift to company specific performance providing a ‘richer environment for stock-pickers’.

In particular the team highlighted £10.9bn Scottish Mortgage (SMT ), which it views as a ‘bellwether’ for the style of investing. While its share price has been dictated by interest rate expectations the Numis team think the ‘unique portfolio’ has ‘return drivers that have a potential to deliver regardless’.

The current 10% discount, significantly narrower than the 20% it sat on at various points throughout 2023, should still be seen as an ‘attractive opportunity’ the note said.

It pointed to the private portfolio which the team view as a ‘key catalyst’ to growing shares and said a ‘visible’ development such as a Northvolt flotation or advances at SpaceX would help shift sentiment.

Numis also highlighted £2.1bn Smithson (SSON ) and £409m Chrysalis (CHRY ), which sit on discounts of 12.9% and 50.6% respectively as opportunities to access cheap growth.

According to the broker, Smithson fund manager Simon Barnard has ‘learnt lessons’ from 2021 ‘when he was caught holding numerous stocks with high valuations’ and some that had ‘small operational issues that should have acted as red flags’. While the investment policy has not changed Banard is ‘now more valuation aware’ and downside in the current discount is ‘limited by [share] buybacks’.

With regards to Chrysalis, Numis believes the out-of-favour fund is maturing nicely it should be an ‘interesting time’ for the portfolio over the next 12-18 months. At a hefty discount with possible exits on the cards, now was a good opportunity to snap up shares, Numis said.

Unloved UK

Doom and gloom was particularly prevalent in the UK market last year where the lack of exposure to technology and growth meant is lagged US performance and it also suffered as institutional and wealth managers ‘now typically align portfolios to global benchmarks’.

This dynamic has combined to make some compelling options for investors such as £904m Fidelity Special Values (FSV ) on a 7.5% discount.

Contrarian manager Alex Wright has an ‘exceptional’ track record, according to the analysts, who pointed out underlying annual investment returns of 12.6% under his stewardship compared to 7.5% for the FTSE All Share.

‘The fund is structurally overweight small-mid caps, where we believe there is considerable value on offer following a difficult two years in light of uncertain economic conditions,’ Numis said.

Sticking with this theme their other suggestion for the UK was £609m Henderson Smaller Companies (HSL ) on a 9% discount.

The portfolio is trading on 9.6 times forecast earnings which compares to a five-year average multiple of 13.6 times, which is unusually below the index were forward earnings are valued at a multiple of of 9.7.

‘We believe that this represents a compelling entry point to a high-quality, growth-biased portfolio,’ the analysts said.

Emerging markets

Emerging markets have underperformed developed markets for around a decade but there are signs that a revival could be on the cards and while headline figures last year disappointed several individual economies, such as India and Korea, performed well.

India has benefited from a diversification away from China and while it may now appear expensive to some, the analysts at Numis think ongoing reforms and attractive demographics will be helpful for the economy and earnings growth.

The team likes £668m JPMorgan India (JII ) on a 15.8% discount. The fund recently underwent a management change and is now run using the same principles as JPMorgan Emerging Markets (JMG ).

‘The new managers made changes to the ensure that all companies met their quality threshold, reducing exposure to value opportunities,’ Numis said, ‘Portfolio changes since the managers took over include exiting and reducing lower quality stocks in capital-intensive, competitive and less profitable sectors, such as real estate, energy and telecoms, as well as second-tier IT services and financials in preference of higher quality names.’

Vietnam has also been beneficiary of the drive away from China and the investment company sector is blessed with three closed-end funds dedicated to the country. The Numis prefer £699m VinaCapital Vietnam Opportunities (VOF ) trading on a 19.5% discount.

The investment company benefits from the country’s cheap valuations and strong manufacturing and also has a diversified portfolio of both private and public companies.

Numis also highlighted £274m BlackRock Frontiers (BRFI ) on an 8.3% discount as an ‘attractive way to gain exposure to a broad range of frontier markets’.  

Life sciences

The fall in the biotech market since 2021 has been spectacular with the Nasdaq Biotech index dropping to 35% below its peak in late October last year before rallying in the last two months.

While the Numis team anticipates the tougher environment will produce some business failures, the fundamentals of the sector remain strong and active managers have the potential to add value.

They are confident in Alisa Craig and Marek Poszepczynski of £255m International Biotechnology (IBT ), which trades on a 8.6% discount.

‘The managers have recently been adding to earlier stage, emerging biotech in which they see the most value, an area that is particularly sensitive to changing interest rates,’ Numis said. ‘The fund is differentiated through its dividend policy, 4% of opening NAV and risk-aware approach to binary events.’

They also like £230m RTW Biotech Opportunities (RTW ), recently tipped by this website, which sits on a 25.8% discount and offers value thanks to its ‘highly differentiated, science led-approach’.

‘RTW seek to identify transformational assets and have the ability and expertise to invest at any stage of the life-cycle,’ Numis said. ‘This includes company formation, as it did with Rocket Pharmaceuticals, which it now a listed business and the largest holding, as well as investing in private and public opportunities, as well as royalties.’

Infrastructure

Infrastructure funds have appeared on most brokers’ New Year recommendations so far as they were some of the worst-hit listed funds last year when investors looked to high interest rates to deliver income.

Numis said investors should be swayed back to the sector due to its ‘compelling earnings visibility and potential for capital growth’ and added that management teams and boards have sought to reinforce confidence in earnings and portfolio valuations.

‘We recommend exposure to a broad spread of infrastructure strategies to achieve the best combination of income quality and capital growth potential,’ the note said.

In the core infrastructure bucket the team backs £2.5bn International Public Partnerships (INPP ) on a 15% discount. The portfolio is ‘more diversified by revenue mix’ then its peers and offers exposure to ‘parts of the market that are difficult to access in any meaningful way  via other strategies’.

‘Overall, the portfolio offers a high degree of inflation protection, which combined with long-term earnings visibility suggests the fund can continue to deliver its historic dividend growth rate of 2.5% a year for at least another 20 years,’ Numis said.

Bluefield Solar (BSIF ) is the team’s pick for renewables generation, a sector of the trust market that has expanded rapidly in the past decade and now includes 12 funds.

Shares in the £718m investment company trail on a 13.5% discount despite having one of the highest growth rates in its sector with net asset value advancing by an average of 9.8% a year, thanks to the management’s skill at developing and sourcing new assets.

The 7.4% yielder has the opportunity for ‘meaningful growth’ thanks to a recent strategic partnership with GLIL Infrastructure.

Meanwhile, in the beleagured digital infrastructure corner space, Numis prefers £583m Cordiant Digital (CORD ) to Digital 9 Infrastructure (DGI9 ), which struck problems due to its high dividend target set at launch.

Cordiant on the other hand ‘set a sensible dividend target, which remains fully covered’. On a 31.3% discount, the investment company had been ‘unfairly impacted by negative sentiment to DGI9’ the team said.

‘It has compiled an interesting mix of portfolio companies, acquired at what appear to be attractive prices, and which have capacity to self-fund growth, and drive long-term returns in line with target,’ the broker added.

Private equity

As companies stay private for longer the team at Numis said listed private equity funds offer a ‘tried and tested route’ for investors.

The sector struggled in 2023 as investors grew nervous over valuations as interest rates rose and this had left funds with high quality managers trading at a good price.

The team pointed to £1.9bn HgCapital (HGT ), £862m Oakley Capital (OCI ) and £406m Pantheon International (PIN ), which offer discounts of 12.3%, 27.9% and 20.5% respectively.  

‘Valuing private companies is always as much art as science and there is never a “right” answer,’ Numis said. ‘As a result, transactions that see third parties invest additional capital are the best “proof” of valuation.’

The broker noted that while exits have been lower in 2022 and 2023 the ones that have occurred happened at ‘significant uplifts’ to carrying value which highlights conservative valuations.

Property

While high interest rates and bond yields depressed property trusts in 2023 the Numis team highlighted there was a sectoral divergence that will continue to be acute in 2024.

Industrial assets and retail assets held up relatively well in the difficult environment, while offices saw a notable decline. This along with focusing on conservative balance sheets and rental growth prospects led the team to pick a handful of real estate investment trusts (Reits) with promise.

These include £575m Urban Logistics (SHED ), £377m Custodian Property Income (CREI ), £789m UK Commercial Property (UKCP ) and £370m Picton Property Income (PCTN ), which were on a 24.8%, 9.1%, 23.5% and 29.4% discounts respectively.

Specialist

The team at Numis also took the opportunity to highlight a number of niche opportunities it believed were worth a look or had a catalyst for improvement.

The £7.4bn, FTSE 100 listed Pershing Square (PSH ) looks neglected on a 30% discount which the researchers believe is highly attractive given manager Bill Ackman’s ‘strong track record’.

‘The discount is somewhat entrenched and we do not see immediate catalysts for it to narrow, although we note that the board/manager have highlighted the possibility of moving the listed to the US as a holding company,’ Numis said.

Numis also picked TwentyFour Income (TFIF ) believing its asset-backed securities and secured loans would be ‘resilient’ in the face of deteriorating economic conditions.

They also agree with Migo Opportunities (MIGO ) manager Nick Greenwood that Georgia Capital (CGEO), which is on a 55% discount is ‘undervalued’ as the country edges closer to joining the European Union, a move that could provide a ‘meaningful tailwind’ to the economy.

‘We believe there may be scope for further realisations given the maturity of some of the businesses, which might provide further cash for distribution,’ Numis said.