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Making the most of opportunities

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19 June 2015

David Prosser looks at how discounts can maximise returns.

How many times have you read that investment companies are more complicated and risky than other types of funds because their shares trade at a discount or premium to the value of their underlying assets? For many advisers, this is the stock-in-trade cliché they reach for when asked if they’ve ever thought about recommending a closed-ended fund to clients.

There is, of course, no arguing with this sentiment. Invest in a closed-ended fund and you have to worry about both the value of the assets and the share price movement – open-ended fund investors, by contrast, only have the first of those anxieties to contend with.

Still, isn’t this the sort of issue that investors pay their advisers to take a view on? Is this issue really so difficult to grapple with that advisers have no choice but to give the investment company sector a wide berth?

Try turning these questions around. A better debate for advisers to have is what their clients might be missing out on by avoiding investment companies. In which case, take a look at analysis published this week by FE Trustnet, which identifies a string of investment companies where investors have earned handsome returns from narrowing discounts over the past three years.

The best example, this analysis suggests, is 3i Group, where the fund management team produced net asset value returns of 45 per cent over the three years to mid-June. However, thanks to an astonishing swing in its discount – which went from around 30 per cent to a premium of 36 per cent over the same period – the shares generated a return of 199 per cent. That’s 154 percentage points of extra performance courtesy of the fund’s discount narrowing.

This is an extreme example, but FE Trustnet identifies several other impressive instances of this phenomenon. Lindsell Train, for example, was up 222 per cent on a net asset value basis over the same period, but its share price gains delivered a return of 323 per cent. A 6 per cent discount three years ago has moved to a 22 per cent premium today.

The effects can be marked even over short term periods. The newly-launched Woodford Patient Capital Trust, for example, opened for business last month with its shares trading on a premium to the value of its assets of 4 per cent. Since then demand for the shares has seen that premium increase to 10 per cent. As a result, investors have earned an 11 per cent return on their capital, despite the fund’s net asset value rising by only 3 per cent.

Now, investing in this way is not without risk. Discounts and premiums can move in the wrong direction, reducing returns or exaggerating losses. And the across-the-board narrowing of investment company discounts we have seen over the past few years means it may be harder today to find the bargains than in the past.

Still, there will always be individual funds that, for whatever reason, fall from favour for a period, creating valuation opportunities for advisers who do their homework. And that, in the end, is how the best advisers earn a living – not by keeping their clients out of supposedly complicated and risky investments but by helping them to exploit the opportunities these nuances regularly throw up.

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