Investment trusts and funds to buy on the cheap

This is also the case with funds, few of which have escaped the coronavirus sell-off. Of the 4,236 funds included in Investment Association (IA) sectors, 3,953 made a loss in the first quarter of 2020, according to FE data. Just 283 funds, or 6.7 per cent of the total, ended the period flat or made a positive return. And less than a tenth of the 513 investment trusts included in Association of Investment Companies (AIC) sectors managed to avoid a drop in their share prices.

Some of these funds look particularly cheap: nearly 1,100 open-ended funds were down by at least 20 per cent over the first quarter and 278 investment trusts' share prices dropped by a fifth or more. So the coming weeks and months could be a perfect time to top up on favoured holdings or find good entry points for promising funds.

But it is very important not to buy funds that have sold off for a good reason and may never recover. Rather, seek funds that appear to have sold off excessively.

Resilient fundamentals

Broad sell-offs can be a gift for bargain hunters because almost everything falls in price. Identifying funds that have been dumped by nervous investors, but still appear sound in the long run is one way to pick good holdings.

Investment trusts that focus on assets that are uncorrelated to equities and should fare well in difficult economic conditions can be a particularly good way to do this, as many have experienced share price falls – even though this may not be the case with the value of the assets they hold. The table shows how some types of investment trusts are priced versus their 12-month average.

One area that has stood out in this respect is infrastructure. The asset class has proved highly popular with investors because it can offer stable returns that hold up in recessions and periods of inflation. But infrastructure exposure has tended to come at a price, with many investment trusts focused on this area trading at a hefty premium to the value of their underlying assets. However, these premiums have fallen. General infrastructure investment trusts were on an average premium to net asset value (NAV) of 2.5 per cent on 6 April, in contrast to their 12-month average of 13.6 per cent. And renewable energy infrastructure trusts, on average, were on a premium to NAV of 2.7 per cent compared with their 12-month average of 10.3 per cent.

James Calder, research director at City Asset Management, believes that good entry points have emerged. So his team are increasing their clients' exposure to trusts such as JLEN Environmental Assets Group (JLEN), International Public Partnerships (INPP) and Sequoia Economic Infrastructure Income Fund (SEQI).

JLEN Environmental Assets invests in environmental infrastructure projects such as renewable energy generation. At least half of its portfolio, by value, is based in the UK. International Public Partnerships focuses on “high-quality, predictable, long-duration public infrastructure projects internationally, or located within core Organisation for Economic Co-operation and Development countries”.

Many infrastructure projects should prove resilient because they are not always reliant on favourable economic conditions and some of their investments even have some degree of government backing. Mr Calder says that other trusts with a focus on government-backed assets, such as residential property fund Civitas Social Housing (CSH), could also fare well.

Income demand

The current environment is extremely challenging for income investors. Interest rates have been cut to new lows while companies around the world are axing their dividends. In the UK these look especially threatened, given that the banks have suspended their payouts, and sectors such as oil and gas are under substantial pressure. This suggests that investors will become even more willing to pay for an attractive yield, resulting in significant demand for income-paying investments.

The investment trusts mentioned above focus on paying a good yield and tend to have stable sources of income, so their share prices could increase in the future as investors pile in. And, as pointed out in the Big Theme of 3 April – Investment trusts to weather the dividend drought – some global equity and UK equity income investment trusts should be able to continue delivering a good income because they can maintain their dividends using revenue reserves. But Mr Calder argues that such attributes are already priced into some of these trusts' share prices, meaning that an uplift is less likely.

However, other asset classes could ultimately benefit from an accelerated hunt for yield. Guy Stephens, technical investment director at Rowan Dartington, says that careful selections of high-yield bonds could pay off. This riskier area of fixed income has been hurt in the sell-off as investors worry about companies defaulting on their debts, and the IA Sterling High Yield fund sector average was a 14.5 per cent fall over the first quarter of this year.

“Default worries have inevitably pushed the yield spreads [of high-yield bonds] over Treasuries [US government bonds] to extreme levels,” he says. “Many will not default but are offering yields of 15 per cent – just when equity dividends have been cut.”

Mr Stephens adds that bonds in the higher-quality end of the high-yield space may be a good source of income and entice investors. 

You can tap into high-yield bonds via a dedicated fund that largely invests in this area, which carries bigger risks and rewards. Options include Hermes Global High Yield Credit (IE00B4W78028) run by experienced manager Frazer Lundie. 

Or you could get exposure to high-yield bonds via a strategic bond fund that can build up a decent level of exposure to this area, while offsetting the risk with more defensive holdings. Mr Calder suggests Investec Global Total Return Credit (GB00BFM79K62), which had more than 40 per cent of its assets in high-yield bonds at the end of February.

Time to buy equities?

Equity funds have been hit especially hard by the collapse in investor confidence. The volatility inherent in this asset class and lack of clarity about the duration of the coronavirus pandemic means that bargain hunters should be especially prudent with this asset. But, here too, focusing on areas that have been unduly punished may pay off in the long term.

Simon Evan-Cook, senior multi-asset manager at Premier Miton Investors, suggests looking to UK smaller companies funds, which have fared worse than their large-cap peers.

“Generally, everyone hated the UK before and people are selling everything that has signs of weakness," he says. "If you have a five- to 10-year view I would focus on UK small-cap value, although it could be very volatile for the next two to three years as we move through what results from this virus.”

Mr Evan-Cook and his team like VT Teviot UK Smaller Companies (GB00BF6X2124). This relatively new fund launched in 2017 and focuses on well-run companies that have been unduly punished by markets.  

Will Dickson, chief investment officer at P1 Investment Management, is instead using UK funds with a mid-cap bias such as Artemis UK Select (GB00B2PLJG05) and Franklin UK Mid Cap (GB00BZ8FPJ50).

Mr Evan-Cook more generally believes that a tilt to funds that have a value investment style could pay off. He argues that the value style – investing in shares which you think appear to be trading for less than their value – has tended to fare well in crises and in periods of inflation, and the latter could emerge following the heavy fiscal stimulus being enacted around the world.

Outside the UK, he believes that value investing gets good results with Japanese equities. Funds focused on these that take a value investment approach include Man GLG Japan CoreAlpha (GB00B0119B50).

Global equity funds with a value tilt, meanwhile, include Lazard Global Equity Franchise (IE00BF2N1T73).

If you favour value style investing it is best to tilt your portfolio to it, rather than going all in, given the fact it has underperformed other styles for such a long time. Also, try to assess how generalist funds are positioned because many added a value tilt last year.

You may also want to consider equity funds that have maintained a high cash level, as they should now be able to put this to work in falling markets. UK equity funds with high cash allocations include JOHCM UK Opportunities (GB00B95HP811), which had 16.3 per cent of its assets in it at the end of February. As mentioned in the Big Theme of 7 February – When funds hold too much cash – it is worth checking how accurate a fund’s stated cash position is before investing in it for this reason.

Deep value

The funds that have suffered most in the sell-off are likely to have done so for a good reason. Energy funds have incurred huge losses, and funds with a focus on Brazil or Latin America and some UK equities funds have also experienced substantial falls. If you feel brave, you could add some exposure to sectors such as energy – as long as you realise how speculative this might be. The oil price has moved as low as $20 (£16.28) a barrel in recent weeks, but could eventually recover.

Mr Evan-Cook says that if you are prepared to “take a punt” you could get exposure via an exchange traded fund (ETF) focused on oil or energy such as Amundi MSCI Europe Energy UCITS ETF (ANRJ). Or you could get it via established active UK value funds such as Schroder Income (GB00BDD2DW68) and Man GLG Undervalued Assets (GB00BFH3NC99).

But caution is warranted. As Mr Calder notes, a shift away from fossil fuels and the general volatility of the oil price could make energy plays “akin to tossing a coin”.