Scottish Mortgage and the fair price of risk

Investment trusts are a great vehicle for taking advantage of a fund manager’s skill in rising markets. Sometimes the momentum in the underlying assets is lagged by the trust share price and there are gains to be had as the discount closes. In other instances, the trust shares are priced at a premium to the NAV because the prospects for the portfolio is attractive enough to pay extra for and the trust shares offer a way of getting in on diversified and often hard to access growth (in the case of overseas shares and unlisted companies) that seems on the cusp of a powerful catalyst.

Prior to November 2021, the former dynamic favoured the methodology of our Alpha Investment Trust screen system which ranks discounted trusts on the basis of discounted trust shares’ cheapness against NAV (relative to their own history) and their share price momentum.  Implicitly the NAV also has momentum and the system flags the trusts offering the best value plays on the hot themes of the day. 

The trouble with momentum systems is they have a pretty awful reverse dynamic when markets hit the skids and that has been the case for trusts in the 10-stock portfolios selected by our system since the end of 2021. There is some optimism that interest rate hiking has peaked, so one could now argue that the discount widening dynamic for investment trusts has, too. 

The possibility of harsh ramifications for the economy (even if recessions are avoided or turn out to be short and shallow) could still be ahead of us, which means regardless of the merits of mega themes trusts give exposure to, investors are just more cautious about growth.  Growth focussed trusts being on a discount could be an argument that they are pricing in a margin of safety for the themes they give access to. 

In other words, the trust discount is a ‘risk premium’ for investors concerned about growth prospects and, in some cases, also the liquidity of certain unlisted assets. With that in mind, investors should ask themselves whether discounted investment trusts are really a bargain or just fairly priced for the risks their strategies and the current economic and financial conditions entail.

The focus for this month’s write-up is on two growth trusts that have been great vehicles in the past and which provide diverse, but not low-risk, exposure to an uncertain future: Scottish Mortgage Investment Trust (SMT) and The Monks Investment Trust (MNKS).