With the average investment trust discount at just 3 per cent – the lowest on record – closed-ended investors have found it increasingly difficult to find value opportunities.
The UK Smaller Companies sector has seen particularly big moves in discounts, thanks to its stellar performance since the financial crisis.
Small and mid-caps have had a tougher time since February thanks to a spate of downgrades, though the FTSE Small Cap index is still in positive territory for the year.
However, the softer period of performance has been enough to prompt investors to take profits from small cap trusts en masse, pushing all but one onto a double-digit discount.
The widening discounts have contributed to the IT UK Smaller Companies sector average underperforming the FTSE Small Cap index considerably this year, with losses of 4.51 per cent.
Iain Scouller, an analyst at Oriel, thinks that the correction has been over-the-top, and highlights a number of trusts that are now at attractive entry points.
“The correction in the valuations of small and mid-caps has been accompanied by a sharp move in discounts on investment trusts specialising in these areas,” he said.
“The average UK small cap trust discount has risen from 7 per cent to 12 per cent, between the end of February 2014 and 9 July 2014.”
Performance of sector and indices in 2014
Source: FE Analytics
“The move in discounts on some individual trusts has been even more marked with Henderson Smaller Companies moving from a 9 per cent discount to 15 per cent, Aberforth Smaller Companies widening from 3 per cent to 11 per cent and BlackRock Smaller Companies rising from 7 per cent to 14 per cent.”
The only trust that isn’t currently on a double digit discount is FE Alpha Manager Harry Nimmo’s Standard Life UK Smaller Companies trust, which is trading on a 6 per cent discount.
However, this is vastly wider than its one and three year average of 0.63 and 1.94 per cent, respectively.
A combination of falling net asset values (NAVs) and widening discounts have seen particularly poor performance from Nimmo’s Standard Life trust, which is down 15.69 per cent in 2014, according to FE data.
BlackRock Smaller Companies and Throgmorton IT have also had a miserable year, both down more than 12 per cent.
However, the returns of the vast majority of trusts in the sector are still very strong over three and five years, with all but two retuning in excess of 150 per cent over the latter period.
The best performer over five years – Strategic Equity Capital IT – has returned an impressive 376.33 per cent.
Performance of trusts and indices over 5yrs
Source: FE Analytics
Scouller points out that small cap trusts have historically outperformed their larger cap rivals over the long-term, and that steep market corrections have usually proven to be a good time to buy.
“Whilst this divergence between the FTSE 100 and small and mid-cap may continue for some time, the shakeout in the sector means that in discount terms, a number of these trusts are now offering some value, with many at, or close to their ‘cheapest’ levels in discount terms for the past year,” he said.
“This may be a good time for investors to revisit our preferred trusts in the sector. These include Henderson Smaller, which has a consistent long term record and a focus on growth stocks.”
Oriel also likes FE Alpha Manager Richard Plackett and Mike Prentis’ BlackRock Throgmorton IT, which has the ability to add-value by taking short positions, through the use of contracts for difference (CFDs).
Charles Cade (pictured), investment trust analyst at Numis Securities, agrees that the correction in small cap trusts has gone too far, and highlights two of his favourites.“It’s an area that has a lot more value in it than before,” he said.
“Everything seemed to change in April. Looking at the open-ended [UK Smaller Companies] sector, there was 20 consecutive months of inflows, and that suddenly reversed.”
“A lot of it is profit taking as they’ve had such a good run. They are certainly more attractive if you are buying now, and crucially a lot of them will protect their discounts on the way down by buying back shares, which gives investors an element of protection.”
“I like the Henderson Smaller Companies trust, which has gone all the way out to 15 per cent. It has a very attractive base fee [0.5 per cent] and manager has a very good and consistent long-term track record.”
Performance of trusts, sector and index over 10yrs
Source: FE Analytics
“From a value perspective we like Aberforth, and BlackRock has two good trusts [in BlackRock Smaller Companies and Throgmorton.”
“Plackett has recently gone on sabbatical. Prentis is a very good manager, but it’s still something to think about.”
Cade’s colleague Euan Lovett-Turner recently said he expected Plackett to return revitalised after a break from fund management.
While Henderson UK Smaller Companies IT has a low annual management charge, the performance fee has pushed the ongoing charges figure to over 1 per cent over the last 12 months.
Among the cheapest in the sector is the £1.5bn Aberforth Smaller Companies IT, which has an OCF of 0.79 per cent and doesn’t have a performance fee.
