If investing is fraught with complexity, understanding the small print can also be a route to better results. Such is the case with investment trusts: from the use of gearing to an ability to boost dividends by dipping into capital reserves, characteristics that make trusts more complicated than open-ended funds can also translate into better returns when used wisely.
The same logic applies to the share price dynamic. Investors can enter or exit investment trusts by trading their shares on the secondary market, as opposed to the transfer of open-ended fund units between an investor and fund provider. This means that investment trusts can prove more vulnerable to shifts in sentiment on the underlying market, with share prices moving accordingly. Those who monitor these price trends closely can potentially stay ahead of the curve – either by buying into a good trust at a cheap price in times of undue gloom, or selling down a name that has started to look overvalued.
As with any investment call, the market price should not be the leading factor in your decision. Instead, you should always focus on the fundamentals first, including the investment manager’s philosophy, approach and track record, the outlook for the underlying asset class and how the trust might fit in with your broader portfolio. But an analysis of investment trusts’ current share prices versus their average levels can highlight names you may wish to buy or sell.
The table below gives an overview of how investment trust shares in different areas are trading in relation to the value of their underlying assets, and how this compares with the 12-month average. The trust categories used are those set by broker Winterflood, and small and mid-cap trusts are not included in the equity groups.
As the table shows, the biggest slides in price relative to net asset value (NAV) have occurred across a variety of areas: biotechnology and healthcare trusts have, on average, seen their discounts widen in the past year, but so have those with a focus on asset-backed holdings, trusts that buy equities and property in the UK, and closed-ended global equity funds.
In some cases, the average has been influenced by an outlier, where a decline in the share price appears well founded. For example, the UK All Companies average discount looks relatively stable once the stricken Woodford Patient Capital Trust (WPCT) is stripped out of the results. The trust could see its fortunes improve if Schroders, its incoming investment manager, can successfully overhaul the portfolio. But for now significant challenges lie ahead, meaning the trust sits on a 47.6 per cent discount to NAV versus a 12-month average of 26.2 per cent.
Similarly, global trusts appear to be losing favour, but much of this is down to sentiment around the Lindsell Train Investment Trust (LTI). The popular trust’s huge premium to NAV has moderated somewhat, from a 12-month average of nearly 60 per cent to the early December reading of 33.9 per cent. While the underlying investment portfolio has continued to perform well, investors might wish to get access to many of the same companies but take less share price risk by, for example, using the open-ended Lindsell Train Global Equity fund (IE00BJSPMJ28). A major difference between the two is that the investment trust has around half of its assets in investment management company Lindsell Train itself.
The average share price for the asset-backed category has also declined versus NAV, but this is exaggerated slightly by difficulties at Hadrian’s Wall Secured Investments (HWSL). The trust’s board announced last month that it would incur a “material loss” on two of the largest holdings in the portfolio, Biomass Premium Fuels and Biomass Optimum Fuels.
Each of these cases concerns a trust that either has some obvious challenges or a share price that might look offputtingly high. However, there is a stronger case to make for some other trusts trading below their normal levels.
Risk and reward
The travails of some Woodford Patient Capital Trust holdings are a good reminder that early-stage investments in growth sectors can carry substantial risks. But certain trusts with a focus on biotechnology and healthcare could represent a bargain for investors with a long-term view.
International Biotechnology Trust (IBT) sits on a discount of 2.7 per cent, but has traded at an average premium of 0.6 per cent over the past 12 months. The trust, which focuses on both quoted and unquoted biotechnology shares, has tended to deliver positive NAV returns, with its shares performing even more strongly. The trust made a NAV return of just under 50 per cent in the five years to the end of October, with its share price rising by 77 per cent over the same period. Portfolio manager Carl Harald has argued that while tougher US regulations on drug pricing and broader concerns about global economic growth could hit his sector of choice in the short term, the strength of scientific innovation and the chance that political pressures around drug pricing will ease over time could lead to good performance in the years to come.
In a recent note Priyesh Paramar, an analyst at broker Numis, argued that the trust has been served well by a “heavy emphasis on fundamental research” and a process that involves selling holdings in advance of clinical trials, given the make-or-break nature of such events for the companies involved. Mr Paramar adds that the trust’s investment managers favour companies with strong pricing power, as well as relatively mature businesses.
In the same space, Syncona (SYNC) has also had a difficult year. The trust sat on a small premium to NAV of 3 per cent at the start of December, according to Winterflood data, well off a 12-month average of 17.4 per cent.
Part of the problem stems from two recent successes: the trust made good returns from selling two businesses, Blue Earth Diagnostics and Nightstar, but now needs to put cash back to work. Numis notes that investors have since been “focused on how management will deploy its significant capital resources”. The trust has also been hit by poor performance at Autolus, one of its holdings.
However, the analysts add that these two sales have demonstrated an “ability to deliver significant value creation”. As such, it is worth considering this trust – although with both this and International Biotechnology, it is good to be aware of the risks involved.
In the UK direct property category, Ediston Property Investment Company (EPIC) shares trade at a discount to NAV of 19.4 per cent, compared with a 12-month average of 13.1 per cent. This in part reflects the trust’s focus on the retail sector, which has had a difficult few years. But the fact that it focuses on retail warehouses rather than the beleaguered UK high street could stand it in good stead.
Earlier this year, Investec analysts noted that the trust had “proved resilient” in a time of broader concerns about retailers. They also praised the investment manager’s proactive approach, including its practice of renegotiating lease terms with existing tenants in its properties, and noted that the trust had an attractive dividend yield. The annualised dividend yield came to 6.7 per cent at the end of September. Investors using this trust should be aware that they are buying into an unloved area, and share prices might not recover. But income investors with a patient outlook might find this to be a good fit.
As far as other unloved areas are concerned, UK equity trusts with a value bias and money invested in domestic-facing companies have performed strongly in recent times, in part because a no-deal Brexit now seems less likely than it once did. Winterflood notes that Fidelity Special Values (FSV), Aurora (ARR) and Temple Bar (TMPL) have done well, for example. The broker adds that these trusts should continue to do well if the Conservative party achieves a workable parliamentary majority in this month’s general election, allowing it to pass the latest EU withdrawal agreement. But any outcome that enhances the uncertainties around Brexit, such as a hung parliament, could spell more difficult times for these trusts.
Red hot
Reassessing the strongest performers in the market is just as important as picking out contrarian holdings, and infrastructure is one area that stands out.
The average generalist infrastructure trust trades on a 15.8 per cent premium to NAV, with renewable infrastructure names typically on an 11.5 per cent premium. There has been good reason for this: investors have prized infrastructure exposure because it can be less correlated to equities than other assets and can offer a good yield at a time when many traditional investments, such as higher-quality bonds, do not. Infrastructure has accounted for a large chunk of investment trust fundraising in 2019.
If low interest rates and concerns about the direction of global growth and equity markets persist, many investors might feel content to sit on their infrastructure trust shares even if they look expensive. But now would be a good time to assess why you are holding such trusts and whether they still meet your criteria.
Trusts with a focus on infrastructure in the UK warrant scrutiny, and not just because some could be affected by a surprise Jeremy Corbyn win in the general election and the prospect of certain assets being nationalised. Winterflood analysts recently highlighted comments by some of the leading investment teams in the sub-sector about a “decline in attractive opportunities in the UK marketplace and the resultant need to invest overseas”. As such, it is worth monitoring whether UK-focused trusts are looking overseas, and whether they have sufficient resources and expertise to do so.
However, bar any major upsets, infrastructure trusts with a UK focus continue to hold appeal for now. One trust that has seen its share price suffer on the back of concerns about political developments but has performed well in the longer term is HICL Infrastructure (HICL). Investec argues that conditions still look good for this fund: a Labour government still looks unlikely, and HICL could continue to turn heads because it offers an attractive and growing dividend. The broker also noted that a “highly disciplined approach to balance sheet management and portfolio construction with an intense focus on active asset management, value enhancements and portfolio optimisation” had helped the trust generate good returns since its 2006 launch.
