In the wake of the surprise Brexit vote on June 23 several UK equity investment trusts saw their discounts widen as investors sold off sterling and domestically focused stocks, instead heading for the perceived safe haven of government bonds.
While investor negativity has since cooled, and the FTSE 100 has rallied, the result of the EU referendum has left its mark on closed-end funds, especially on those within the UK direct property sector. It has also created some relative value within two of highly rated closed-end funds.
Commercial Property Trusts Hit
UK commercial property is arguably the sector most aligned with the general health of the UK economy. It has been a very popular area for investors seeking a reasonable and rising level of income over the past few years as rock bottom government bond yields have impacted portfolios.
The Morningstar Closed End Direct UK Property category includes an eclectic mix of 19 investment trusts ranging from Student accommodation and Healthcare specialist trusts to more balanced and diversified funds representative of the broader investable stock of UK commercial property.
According to Morningstar data on May 24 the sector was trading on a premium of 3.5%. By June 27 this premium had given way to a discount of 3.7%. Interestingly by July 22 the average price had recovered to around net asset value.
The specialist funds that focused on specific areas of the UK commercial property market were relatively unchanged thorough this period suggesting that investors here were more sanguine, happy to remain invested through the volatility.
The broader commercial property funds faired considerably worse as less committed investors were shaken out by the volatility. Focusing on five of the more generalist trusts; F&C Commercial Property (FCPT), F&C UK Real Estate Investments (FCRE), Schroder Real Estate Invest Trust (SREI), Standard Life Investments Property (SLI) and UK Commercial Property (UKCM), we can observe that on the May 24 the average discount to the stated NAV was 8.5%, by June 27 this had ballooned to 20% to see some recovery by July 22 to a discount of 11.7%.
Investors should expect these trusts underlying assets to be revalued in the near future, narrowing the discount, but in a world of low or negative interest rates the attractiveness of commercial property within a diversified portfolio looks set to continue.
Top Trusts Trading at a Discount
Relative value has been appearing the Morningstar Analyst Bronze Rated Edinburgh Worldwide (EWI). Managed by Douglas Brodie it shares a similarity of approach to higher profile brethren Scottish Mortgage (SMT) trust managed by the long term global growth team at Baillie Gifford.
As at the end of April, Edinburgh Worldwide held six stocks in common with Scottish Mortgage accounting for around 10% of the portfolio, including such names as Tesla, Splunk and Alnylam Pharmaceuticals. The trust seeks to identify immature but innovative businesses with significant potential for structural growth and hold them for the long term.
Admittedly performance has not been as robust as at Scottish Mortgage and volatility can be high given its focus on nascent global companies, but whereas Scottish Mortgage has tended to trade at around NAV, Edinburgh Worldwide is trading on a 12% discount. For investors willing to accept volatility and with a long term investment horizon in mind we think that this looks an interesting way to play Baillie Gifford’s global stock picking expertise.
Along with commercial property, UK smaller companies are often seen as a purer play on the domestic economy than those listed within the FTSE 100 index which derives significant earnings from overseas. Within the UK Small-Cap Equity category the Morningstar Analyst Gold Rated Black Rock Smaller Companies (BRSC) fund managed by the experienced Mike Prentis looks appealing for those investors willing to take a longer term view within the context of a diversified portfolio.
Mike and his team look for sustainable growth opportunities that meet five key criteria; quality management, strong market position, cash generation, a prior record of EPS growth, and a strong balance sheet. The use of gearing within the fund together with some AIM exposure can lead to above average volatility but investors have historically been rewarded for taking on this extra layer of risk. Recent adverse investor sentiment means the fund trades on a 15% discount. Over the past year this has ranged between trading at around NAV to a near 20% discount.
The fund was not positioned for the Brexit referendum result with a large consumer cyclical weighting and so its NAV fell substantially after the referendum, but it has recovered subsequently. We hold Mike Prentis in high regard and the trust remains one of our highest conviction ideas in the sector.
