Investment trusts that may really be a bargain

Investment trust discounts to net asset value (NAV), on average, widened between the start of the year and September. And although by December they had tightened a bit, they were still wider than at the start of the year, according to broker Winterflood.

The five investment trust sectors that experienced the greatest discount widening over the 12 months to 14 December were Royalties, Property – UK Residential, Property – UK Healthcare, Private Equity (excluding 3i (III)) and Property – UK Commercial, according to broker Stifel.

While this might seem like an opportunity to pick up some bargains, investment trusts can trade at a discount to NAV for a good reason (see box below). So don’t just invest in the sectors and trusts on the biggest discounts to NAV. But in some cases the discounts are not justified, in which case if you were thinking of investing in that area and/or the assets a trust invests in are suitable for your investment objectives, risk appetite and time horizon, it could be worth attention.

Below are some sectors and trusts on discounts that could be worth a look.

Private equity

Private equity investment trusts appear to be on a relatively big discount even if there is a 'haircut' to their NAVs at year-end, according to Iain Scouller, managing director at Stifel. Despite some very strong NAV performance in recent years, private equity investment trusts continued to de-rate significantly in 2022 because of concerns about writedowns due to lower multiple valuations on comparable stock market listed companies, weaker company earnings, and higher debt costs on leveraged structures.

Despite some tightening in the latter part of the year, private equity trusts which invest directly in companies were on an average discount of 27.8 per cent, as opposed to their 12-month average of 19.6 per cent, and private equity fund of funds were on an average discount of 43.1 per cent, as opposed to their 12-month average of 35 per cent as of 20 December, according to Winterflood.

Scouller thinks the discounts are excessive. "We suspect the likelihood of corporate activity in the sector is increasing, and if this materialises, we would expect a substantial positive sector rerating," he explains.

He also notes that the earnings of many of the companies private equity investment trusts invest in are relatively robust, and their balance sheets remain strong. “Catalysts for a rerating of the listed private equity sector could include a significant positive rerating of smaller and mid-cap listed companies, possibly once markets can see beyond rising interest rates,” he adds. “Another factor that would rerate the sector is the emergence of corporate activity.”

So if you are looking for growth over the long term, good options could include HgCapital Trust (HGT), which has a strong long-term performance record, but was on a discount of 20.4 per cent as of 20 December, against its 12-month average discount of 12.8 per cent, according to Winterflood. It invests directly in unquoted companies, mainly software and business service companies with resilient, recurring revenue streams. It holds 46 companies.

"Recent realisations highlight the strong demand for HgCapital Trust's portfolio companies, which provide mission-critical software to diversified customer bases," says Gavin Trodd, associate at broker Numis. "The nature of the companies in Hg's portfolio are significantly different from the blue-sky technology that many investors are most concerned about. Hg focuses on dull tech that seeks to automate business processes and increase efficiency, which should be in high demand in an environment where labour costs are rising, while the business-critical nature of the software provided leads to high levels of recurring revenues and pricing power."

Oakley Capital Investments (OCI) has an outstanding performance record but was trading at a discount to NAV of 38 per cent as of 20 December, wider than its 12-month average of 31 per cent, according to Winterflood. The trust invests in funds run by its manager, Oakley Capital, which invest directly in private companies, and it has exposure to 27 companies.

“Oakley Capital Investments posted a strong third-quarter NAV, up 4 per cent, driven predominantly by earnings growth, which continues to be the significant driver of value increases,” says Trodd. “Oakley Capital has a strong track record in its private funds due to a well-defined strategy focusing on mid-market European buyouts in the consumer, technology and education sectors.”

HarbourVest Global Private Equity (HVPE) is arguably lower-risk because it is more diversified. It mainly invests in other private equity funds rather than directly in companies, so has exposure to more than 1,000 companies. These are in sectors including tech and software, consumer goods, and medical and biotech. The trust was trading on a discount to NAV of 46.8 per cent as of 20 December, in contrast to its 12-month average discount of 36.8 per cent, according to Winterflood.

Also see Time to seize on private equity trusts, discount deals? (IC, 04.11.22)

Core holding

If you are looking for a relatively defensive broad core holding, it could be a good time to invest in multi-asset trust RIT Capital Partners (RCP). It was trading on a discount to NAV of 18.1 per cent compared with its 12-month average discount of 7.5 per cent as of 20 December, which may be in part due to it underperforming broad global indices, the FTSE All-Share and other wealth preservation trusts over the past year. But over the long term, it has succeeded in preserving and growing investors’ capital, although can be volatile in the short term.

"RIT Capital Partners has traded on a discount throughout the year, which is unwarranted given its strong track record and insulation against market declines, albeit with more market sensitivity than some of its peers," says Trodd. "RIT Capital Partners has an exceptional long-term track record through an unconstrained investment approach that seeks to deliver long-term capital growth, while preserving shareholders’ capital. It is differentiated from most investment companies by being self-managed, and its active management of both equity and currency exposure. We think the discount is in part driven by its private equity exposure, however this has been a significant contributor to performance in the past and the trust's manager is confident in its ability to generate future NAV performance."

The trust invests in quoted and unquoted geographically diversified assets. At the end of October, it had 31 per cent of its assets in private equity funds, 24 per cent in absolute return and credit funds, and 21 per cent in quoted equity.

Smaller companies

Smaller companies investment trusts' discounts to NAV have widened this year, in part due to their growth bias and the perception that smaller companies are more exposed to worsening financial conditions. This has been reflected in their share prices, with many selling off.

"We think that a lot of the macro risks are priced in and balance sheets are stronger than they have been in the past," says Trodd. "And attractive valuations lead to merger and acquisition (M&A) opportunities within the portfolios. Discounts have narrowed somewhat in recent weeks, however the UK small and mid cap sector [still] offers value, with Henderson Smaller Companies Investment Trust (HSL) among our preferred picks."

While not at its widest discount level of the past few years on 7.5 per cent as of 20 December, Henderson Smaller Companies Investment Trust has also traded at tighter levels over the past few years. And trusts with the widest relative discounts are not necessarily the best options (see box) while, importantly, this trust looks well-positioned to navigate weak or uncertain economic conditions ahead. Its investment team is being very selective about what they hold because they think that "the strength of franchise, market positioning and balance sheets will likely determine the winners from the losers."

This trust's manager, Neil Hermon, aims to invest in quality growth companies he considers to be at a reasonable price. The trust has an outstanding long-term performance record, having outperformed its benchmark, the Numis Smaller Companies ex Investment Companies index, in all but three of its financial years since Hermon's appointment in 2002. The years of underperformance include Henderson Smaller Companies Investment Trust’s financial year to 31 May 2022, which may be a reason for its discount widening earlier this year.

The trust is differentiated from some of its smaller companies peers by often having a substantial allocation to mid-caps. It had 57 per cent of its assets in FTSE 250 index companies at the end of October, according to the Association of Investment Companies (AIC). This is partly because Hermon retains former small-cap companies that have grown into FTSE 250 companies. It also had 27 per cent of its assets in Aim and Nex market stocks.

At the end of October, it had nearly a third of its assets in industrials, and 22 per cent and 15.5 per cent in consumer discretionary and financials companies, respectively. Its largest holdings at the end of October were Impax Asset Management (IPX), Oxford Instruments (OXIG) and Balfour Beatty (BBY), which accounted for 3.1, 2.9 and 2.5 per cent of its assets respectively.

Tech and biotech

Technology and biotechnology investment trusts have been among the most impacted by rising interest rates. But Trodd argues that biotechnology trusts benefit “from positive tailwinds including favourable regulation, positive demographic changes, strong innovation and M&A. After a number of difficult years for performance in the sector we believe that it presents an interesting valuation opportunity. There will continue to be winners and losers among listed companies based on both the science and ability to finance themselves to key milestones, meaning that investing via a specialist manager with an active approach is likely to be the best option for generalist investors.”

If you are seeking growth over the long term and have a high risk appetite, you could consider Biotech Growth Trust (BIOG), which was on a discount of 8.4 per cent in contrast to its 12-month average of 5.4 per cent as of 20 December. The trust has underperformed the Nasdaq Biotechnology index recently, but in some years, such as 2019 and 2020, substantially outperformed it.

“Biotech Growth benefits from an experienced, well-resourced management team that uses a stockpicking approach based on fundamental research,” comment analysts at Numis. “In recent years, overweight exposure to small-caps has dampened performance as they have underperformed larger peers. Additionally, exposure to China has been a headwind [but] exposure being reduced. It is positive to see a period of outperformance [over the six months to 30 September], however, some of these gains have been given back following a rally in large-cap names in which the fund is underweight.”

Quoted China stocks only accounted for 2.2 per cent of its assets as of the end of November, with North American listed companies making up nearly 80 per cent.

The trust also invests in Asian unquoted companies, most of which are in China. This adds to risk, but could enhance returns over the long term. And the trust cannot invest more than 10 per cent of its assets in these – at the end of November unquoted investments accounted for 8.2 per cent of its assets.

Technology investment trusts have experienced sharp share price falls with longer-duration growth stocks in particular selling off heavily. “However, with a lot of froth out of the market there is a lot more value on offer,” says Trodd. “This sector is exposed to favourable tailwinds, given that spend on technology by businesses is often seen as critical.”

He highlights Allianz Technology Trust (ATT) which was on a discount of 11.6 per cent as of 20 December. The trust has at times traded at much tighter levels over the past few years and has a strong long-term performance record, although has underperformed the Dow Jones World Technology index over the past year.