Investment trusts are often seen as a more complicated vehicle than open-ended funds. One of the main reasons for this is their ability to trade at a premium or discount to their net asset value – but investors who make the right call could use this feature to significantly boost their returns.
If you buy a trust when it is trading at a discount of, say 10%, and this closes to the point the trust is trading at par then you have made 10% on your investment before even factoring in any capital growth or dividend. This is simply because buyers are now willing to pay more than you did for the shares.
Of course, this works the other way too. You might buy shares at par or when they are at a premium only for them to fall to a discount. In this case, if an investor wants to offload their shares they will have to sell them for less than they paid and potentially less than their intrinsic value.
Whether a trust trades at a premium or discount is not always a reflection of its performance. Trusts can find themselves punished because their style is out of favour or because there is negative sentiment towards the region or asset in which they invest.
Investors who are willing to make a contrarian bet may find there are bargains to be had among this crop – but the trick is not to fall into a value trap, whereby a trust is cheap for a very good reason.
Extreme Discounts
Patrick Thomas, investment manager at Canaccord Genuity Wealth Management, explains: “Generally it’s a value trap when the discount is a reflection of poor performance, when NAV has underperformed for a long period of time, the manager’s process is under scrutiny and you’d need to see a change to be confident the discount would revert to historical norms.”
Currently examples of trusts on the most extreme discounts include RDP Global Resources (GRIT), which is currently trading at an eye-watering discount of 51.7%. Premier Global Infrastructure (PGIT) is on a discount of 40.8% and Tetragon Financial Group (TFG) 40.1%.
Rachel Winter, senior investment manager at Killik & Co, says: “Many investment trusts have traded on significant discounts for years. There’s little point buying a trust purely because of the discount and if you are, it’s important to consider whether there is a catalyst for that to change.”
This might occur, for example, when a new management team is brought in. Monks Investment Trust (MNKS) had sat at a discount of around 10% for a number of years due to lacklustre performance. In 2015, Charles Plowden took over the running of the trust and performance picked up significantly. That has attracted investors’ attention and the trust now trades at a slight premium.
A revaluation of unlisted holdings in an investment portfolio may also prompt change. Woodford Patient Capital Trust (WPCT), for example, traded at a premium when it first launched but has since fallen to a discount of more than 13% as sentiment has turned. Winter says: “Much of the portfolio is privately held companies that are valued infrequently, which makes it difficult to calculate the true net asset value of the trust and, therefore, its true discount. A positive revaluation of an unlisted holding could boost sentiment and narrow the discount.”
Discounted for a Reason
But it’s important to consider the wider context, and not just focus on a trust’s share price. Some have discount control mechanisms in place whereby the trust will buy back its own shares if the discount reaches a particular level, while others are happy to let market forces dictate the price.
Thomas adds: “The fact that a discount is wider or narrower than its historical average does not actually tell you very much and gives you no indication when, or if, it will revert.”
Another example is JP Morgan Emerging Markets (JMG); a top-quartile performer in its sector, the trust has outperformed both its peers and benchmark over five years, yet it currently trades close to its widest ever discount, at almost 13%. Thomas says: “Does that make it a buying opportunity? Not really. Closed-end emerging market investments have generally underperformed open-ended alternatives and tend to be expensive. The sector trades at a discount for a reason and this is simply the best of a bad bunch.”
But occasionally there are opportunities to be found among discount trusts, particularly those where the manager has a strong track record and is running a fairly simple strategy, says Thomas.
He points to Fidelity Japan Trust (FJV), which is currently trading at a significant discount to its peers at around 10%. Nick Price took over the running of the trust three years ago after a period of underperformance. Thomas says: “Manager Nick Price has an 18-year track record of outperformance but investors are either unaware of the manager change or wish to see evidence the new team has made a difference.”
Despite this, he doesn’t believe this should be any investor’s starting point for picking a trust. He says: “You generally invest because you believe the manager is going to outperform over time. Buying a trust in the hope of the discount driving your returns is like trying to run a marathon by drinking a lot of energy drinks but doing no training.”
