Engines of growth

A key driver of the price of any listed security is sentiment so, not surprisingly, some of the investment trust sectors which have experienced the most extreme discount and premium movements this year are those about which there has been particular concern or hope. In general, there has been more discount widening than tightening over the first 10 months of 2020.

Some of the sectors that have experienced the greatest discount widening are property-related. Since the onset of the coronavirus pandemic earlier this year, retail premises and offices in particular have been negatively affected. In some cases, the owners of such properties have not been paid all the rent they are owed because national lockdowns have resulted in the closure of shops for many weeks. And with many employees working from home offices have been also been empty or not as fully occupied. As home working has often proved to be successful, even if there is a return to normality in the coming years companies might not want to pay for as much office space so demand for this kind of property might fall.

However, the average discount for a given investment trust sector is just that, and within sectors there can be great disparity between the ratings individual trusts are on. Also, if one trust in a sector experiences an extreme movement in its rating, it can distort the average figure for the sector overall. This is especially if there are not many trusts in the sector as is the case with a number of investment trust sectors.

Gavin Haynes, investment consultant at Fairview Investing, says that property investment trusts sectors are a prime example of where there can be great disparity between individual trusts. “You really have to dig down because there will be both winners and losers,” he says.

Even if an individual trust or sub sector is doing well and or has better prospects, if investors are bearish about the broad asset class their share prices can still do badly, leading to discount widening. Mr Haynes says that while many mainstream commercial property trusts with substantial exposure to areas such as offices and retail premises have been hit hard and may continue to struggle, others which are also on discounts look attractive.

“There has been indiscriminate selling in the commercial property space,” he says. “Logistics providers are benefiting from move to online shopping but are still on wide discounts.”

Some investment trusts mainly invest in logistics properties such as warehouses, which have benefited even more in recent months because the coronavirus outbreak and closure of high street shops have accelerated the move to online shopping.

But this has not necessarily been reflected in Tritax EuroBox’s (EBOX) rating, which at the end of October was on a discount of 12.5 per cent – much wider than where it was earlier this year or in previous years. The rating has not been helped by some concerns specific to this trust, which has a relatively concentrated portfolio of 12 assets, the largest of which is a warehouse let to retailer Mango. However, as of 31 July all of Tritax EuroBox’s agreed rent due had been paid and it had not received any more requests from occupiers of its properties to waive or defer rent. The trust said in August it was also in a strong financial position with cash and undrawn facilities in excess of €100m (£89.26m) as at 30 June 2020.

The Association of Investment Companies (AIC) Property - Europe investment trust sector is also a fairly mixed bag, with some of the trusts in it focused on logistics, while Schroder European Real Estate Investment Trust (SERE) has investments in retail premises and offices. This was trading at a discount to NAV of 31.6 per cent as of 10 November, while Tritax Eurobox was on a discount of 9.5 per cent and Aberdeen Standard European Logistics Income (ASLI) was on a premium of 10.1 per cent.

The Leasing sector has experienced discount widening because it includes a number of aircraft leasing funds. Lockdowns and quarantine rules for travellers have resulted in a steep fall in air travel. But this small sector’s figures have also been skewed by one trust with its own particular problems. KKV Secured Loan Fund (KKVL), which leases equipment to small- to medium-sized enterprises, may be subject possible value impairments in parts of its portfolio. It traded at a discount to NAV of 75.9 per cent as of 10 November, wider than that of some of the aircraft leasing funds.

Tufton Oceanic Assets (SHIP), meanwhile, which leases ships, was on a discount of 7 per cent as of 10 November. This trust is managing to lease assets and make profitable disposals, such as the recent divestment of a tanker for $19m (£14.34m), for which the realised yield and internal rate of return exceeded targets. Read more on this investment trust in our professional picks on pp44-47.

Private equity investment trusts are also among the sectors to experience substantial downward movements in their ratings between the start of the year and the end of October.

“Private equity trusts took a real hammering because they over committed [to investments ahead of] the global financial crisis,” says Matthew Read, senior analyst at Marten & Co. “But they are in a better position now and most are not over committed. Some of them are sitting on big cash piles and, as they invest for the long term, a market shocker can lay the foundations for [good investments and performance]. If you take a long-term view it might be a good time to invest in these.”

He says that HarbourVest Global Private Equity (HVPE), a fund of private equity funds, is well managed though not necessarily cheap. After briefly plunging to a discount of over 50 per cent in March this trust’s rating has tightened considerably to 17.3 per cent as of 10 November.

Mr Read says that Standard Life Private Equity Trust (SLPE) is also a good way to get diversified exposure to this asset. It was on a discount of 26.4 per cent as of 10 November, tighter than earlier this year but wider than where it has sometimes been in the three prior years.

Apax Global Alpha (APAX), which invests in both other funds and direct investments, is on a relatively wide discount compared with where it was early this year and last year -21.6 per cent as of 10 November.

Equity investment trust sectors focused on the UK have also experienced discount widening. UK equities have been out of favour due to uncertainty over Brexit, in particular smaller companies, which are more exposed to the domestic economy. Mr Haynes says that equity trusts have also been affected due to their style of investing. Companies considered to offer growth and quality have been very popular, benefiting funds that invest in them. But funds which take a value style investment approach – investing in companies whose share price you think does not reflect their real value – have been out of favour.

“Following the [recent] positive news on a [coronavirus] vaccine and if there is a trade deal with the European Union, [certain] investment trusts could exploit contrarian areas which have been hit really hard,” says Mr Haynes. “The UK, particularly mid and small caps [springs to mind]. A recovery could see discounts closing which had widened because of negative sentiment on UK equities.”

A possible beneficiary could be Fidelity Special Values (FSV). The trust's investments include UK smaller companies and its managers take a value style investment approach. At the end of October, this trust was on a discount to NAV of 8.4 per cent – much wider than earlier this year or the past two years when it was mostly trading at either a slight discount or premium. As of 10 November this discount had closed to 1 per cent.

“[Monday 9 November] was a good day for value – not just in the UK but also around the globe,” says Darius McDermott, managing director of research company FundCalibre. “The million dollar question now is whether this value rally will continue or be short-lived. If the vaccine newsflow remains positive value could do well until the end of the year.

"Value funds have had a torrid time over the past decade, as growth strategies have enjoyed the tailwind of a low growth, low interest rate world. But these funds will also have benefited the most from the rally this week [as they are] already invested in out-of-favour companies. Fidelity Special Values is run by contrarian manager Alex Wright, and has a holding in Meggitt (MGGT), the aerospace aftermarket business. [It also holds] C&C (CCR), a drinks business that has been very badly impacted by Covid-19, but which is still making money. However, gearing (debt) on the trust is in the double-digits.”

Think first

With quality growth very popular funds with this focus may continue to do well, while ones with a value investment style could continue to struggle. And, more generally, Mr Haynes urges caution before investing in a trust on a discount, because it is not necessarily a bargain. “The discount may not close and the NAV may not recover,” says Mr Haynes. “These could be value traps.”

Before investing in a trust that appears to be a bargain you should have a good understanding of the area it invests in. This is particularly important with trusts that invest in illiquid assets such as property because it is harder to know the value of their assets. These may be valued a few times a year rather than every day like equities. So, for example, it is difficult to know if a property trust’s stated NAV really reflects the market value of its assets as it may be out of date.

Because of this trusts focused on areas such as private equity often trade at discounts and good performance may not tighten them a great deal.

Trusts often trade at a discount for a valid reason, for example, their performance is not good relative to their benchmark and peers. If the performance doesn't improve, the discount is not likely to come in, so it is not a good idea to buy a poor performer unless there is a reason to believe that it could improve. But if, for example, the trust invests via a style that has been out of favour that looks like it might be making a comeback, it could be worth further investigation.

A discount to NAV can be an indication that something is wrong, in which case the trust is definitely not a bargain. Maybe underlying investments that account for a substantial part of its assets have blown up, it has excessively high levels of expensive debt, or its manager who has been doing a great job has left.

In some cases the trust may be on a relatively tighter discount than usual, which could indicate that it is at the top of its historical range – unless the tightening has been caused by a significant positive change that means it could tighten further. If a trust usually trades at a wide discount and there has not been a change in its circumstances that could make it tighten, it is not a bargain. So check its historical discount record, together with recent reports and announcements. Also see what the trust's discount is relative to the other trusts in its peer group, and their histories.