Numis Securities research shows that the average discount on an equity investment trust is at around 5 per cent, matching the lows of 1995 and 2008.Lyon (pictured) likes to hold investment trusts within his own portfolio, but says the pace of narrowing discounts indicates poor value and low future returns.
“When there are so many new issues, which there has been of late, it’s usually an indication that there is a lack of value, and you’ve had discounts come right in as well,” said Lyon in an exclusive interview with FE Trustnet.
“Lots of alternative areas such as solar energy and aircraft leasing have seen discounts come in a great deal, which is always a warning sign.”
Average discount on an equity investment trust since 1995
Source: Numis Securities
“We’re always on the lookout for investment trusts but with the exception of the Mithras Investment Trust we don’t own any, because there is just no value there.”
“I think it tells you where we are in the cycle – a point where investors are paying high prices for investment trusts that have done well, and not worrying about discounts widening, or even a fall in net asset value (NAV).”
As well as the Mithras trust, which Lyon says has been one of his best ever investments, he had a successful period holding the Alliance Trust, as well as the Rutland Trust which was merged away in 2007.
“We bought an 11 per cent stake of Mithras back in 2002 for 42p and today its NAV is 130p. It’s been one of our best ever investments,” Lyon added.
Lyon says the situation is made even worse by possibly misleading share price data, which includes the impact of gearing and narrowing discounts.
A number of FE Trustnet articles have highlighted the superior performance of trusts versus their open-ended rivals since the financial crisis.
Investors have been much better off in the trusts of star managers such as Harry Nimmo and Alexander Darwall over the past five years, but Lyon says anyone who expects this trend to continue could be set for a nasty wake-up call.
“People forget that discounts have come right in and there’s been a lot of gearing – much of which has been structural,” he said.
“Returns look fantastic, but you’ve got to remember what happens when things go the other way.”
Performance of trusts and funds over 5yrs
Source: FE Analytics
Lyon says that trusts that use discount control mechanisms [DCMs] have in many cases been at a slight disadvantage in recent years, as their share prices haven’t had the added boost of a narrowing discount or rising premium.
Discount control mechanisms were criticised by FE Alpha Manager James Henderson in an article on FE Trustnet this week for destroying shareholder value.
However, given the strong run investment trusts have had in most areas, Lyon says having one now puts them in a strong position.
Both Lyon’s Personal Assets Trust and FE Alpha Manager Francis Brooke’s Troy Income & Growth IT have DCMs.
“We’ve been very, very pleased with the performance of Francis [Brooke’s] trust since he took it over. It’s beaten its benchmark, but versus its peer group it doesn’t look as good as it hasn’t been geared and hasn’t benefited from going on to a big premium,” he said.
Performance of trust, sector and index since Jul 2009
Source: FE Analytics
“My trust has had a difficult time since mid-2012. We’ve lost some money which we’re disappointed about, but if we didn’t have that control mechanism we would probably have been hit by a widening discount. We’ve had to buy back some shares, but actually issued some last week for the first time in six months,” he added.
FE data shows that the Personal Assets IT is down 5.29 per cent over a 12-month period.
Lyon’s 13 per cent exposure to gold and gold equities and a hefty weighting to cash and inflation linked bonds have weighed heavily on performance.
Although Lyon’s emphasis is on capital protection as opposed to relative outperformance, by point of reference the FTSE All Share is up more than 8 per cent over the period.
Performance of trust and index over 1yr
Source: FE Analytics
The manager says he has been encouraged by the trust’s start to 2014 – it is up 4.94 per cent year-to-date compared with a slight loss from the All Share – and insists he will continue to protect against the serious downside risks plaguing markets.
“The market is getting increasingly dangerous. The FTSE was at 3,800 and is now at 6,800 and so naturally we are going to be more cautious as markets and valuations go higher,” he said.
“We don’t think in relative terms anyway. We’re not so clever to say we will put money in and take it out at the perfect time.”
Lyon’s bearish views on valuations and the global economic recovery were examined in more detail in an article earlier this week on FE Trustnet.
Aside from Personal Assets IT and Troy Income & Growth IT, among the high profile investment trusts that use DCMs are the Ruffer Investment Company, Invesco Perpetual Select UK Equity IT, Finsbury Growth & Income and Aberdeen Asian Income IT.
While investment trust discounts have come in across the board, the two notable exceptions are emerging markets and miners, which have had a terrible time of late. Among those on double-digit discounts are Aberdeen New Dawn IT and Templeton Emerging Markets IT.
