One of the major reasons investment trusts tend to outperform the wider market and their open-ended counterparts over the longer term is because of their structure.
Not only do managers have a closed pool of assets (and therefore don’t have to worry about inflows or outflows and can therefore take genuine long-term bets), but they have the ability to gear-up for a rising market and, if demand improves for their shares, their discounts to NAV can narrow which also boosts returns.
Performance of trusts versus funds and index over 20yrs
Source: FE Analytics
Those latter two features, however, can also be very detrimental to trusts’ performance during periods of market stress. Gearing means they are investing borrowed money which needs paying back while negative sentiment can cause discounts to widen, meaning existing investors are hit by the so-called ‘double whammy’ effect of falling NAV and share prices.
Certainly, given what has gone on in markets since late April thanks to all the macroeconomic headwinds which have faced risk assets through to this week’s ‘Black Monday’ (one of the worst days for equities since the global financial crisis), it is unsurprising that many investment trusts have struggled.
Therefore, has this left investment trusts attractively valued from a discount point of view?
Ewan Lovett-Turner, director of investment companies research at Numis Securities, says there are a number of opportunities, but given the severity of the recent falls discounts haven’t widen massively yet across the board.
“I think the market is still waiting for things to settle down a little bit as everything has have moved in the same direction, with NAVs catching up with share prices,” he said.
However, Lovett-Turner points out that there are number of trusts he now finds more interesting as a result of their widening discounts. In this article, he highlights three for investors to consider now some of the market panic has subsided.
First on the list is Schroder Asia Pacific, which is headed up by the long-serving Matthew Dobbs.
It is unsurprising that a trust from the IT Asia Pacific ex Japan sector features on the list, given that the recent falls have been due to concerns about a ‘hard landing’ in China, its plummeting equity market and the country’s authorities’ decision to devalue to the yuan.
Lovett-Turner says investors buying into the Asian region now will need a strong stomach as volatility is likely to persist over the short term. However, given the quality of its management team, current positioning and double-digit discount, he says Schroder Asia Pacific looks attractive.
“Schroder Asia Pacific is one we like as it has a strong long-term track record. Dobbs has been wary of having exposure to mainland China and we would hope that kind of positioning will feed through to NAV performance,” he said.
Schroder Asia Pacific is currently trading on a 10.8 per cent discount to NAV, compared to a 7.5 per cent discount for the sector average. It was also trading on a 6.5 per cent discount earlier in the year, which demonstrates its recent widening.
Despite that, the closed-ended fund has protected on the downside far better than the sector average and its MSCI Asia ex Japan sector. This has helped the trust outperformance over the longer term, which is shown in the graph below.
Performance of trust versus index over 10yrs
Source: FE Analytics
As Lovett-Turner points out, Dobbs is underweight mainland China relative to his benchmark and is also running a 3.2 per cent cash weighting at the moment. It has gearing of 1 per cent and ongoing charges of 1.1 per cent.
Again, it’s not for the faint hearted, but Lovett-Turner says the Genesis Emerging Markets IT looks good on its 9.5 per cent discount. That discount is wider than its one and three-year averages, plus its shares were on a narrow 3 per cent discount at points over the past year.
Emerging market equities have been out of favour for some time now, but with China’s slowing growth leading to falling commodity prices, many expect other large developing economies such as Brazil and Russia to struggle for the foreseeable future.
However, given the long-term growth opportunities that can be found in those regions, Lovett-Turner says the trusts discount looks attractive, especially given the quality of its management team.
According to FE Analytics, Genesis Emerging Markets has comfortably beaten the MSCI Emerging Markets index since its manager, Andrew Elder, took charge of the portfolio in January 2004. It has returned 246.71 per cent, beating the index by more than 60 percentage points in the process.
Performance of trust versus index under Elder
Source: FE Analytics
However, it has struggled more recently thanks to Elder’s value approach and focus on unloved companies – which have been out of favour over the past few years as investors have preferred quality growth companies as sentiment has been very weak.
Genesis is, as a result, underperforming over one, three and five years.
The trust currently holds 54 per cent in Asia, 19.5 per cent in Middle East/Africa, 12.5 per cent in Eastern Europe and 12.2 per cent in Latin America. It isn’t geared but has relatively high ongoing charges figure of 1.67 per cent.
It is logical that a trust which has ‘Energy’ in its name has fallen out of favour as a result of the huge falls in the oil price. FE data shows it is now down 54 per cent over the last year following its 37 per cent fall since May.
However, Lovett-Turner says Riverstone Energy stands out on a medium-term view given its current 18.11 per cent discount the NAV.
While the analyst is making no call on the future of the oil price, which is set to remain weak for some time to come according to most industry experts, he says the trust’s current discount is attractive given the nature of the portfolio.
Riverstone Energy tends to invest in management teams that parent company Riverstone, which specialises in buyout and growth investments in the exploration & production, midstream, oilfield services, power and renewable sectors of the energy industry, has successfully backed in the past.
The team at Numis have been tipping the trust for some time and told FE Trustnet in January that it was a portfolio that could actually benefit from a lower oil price environment.
“Importantly, oil price is not the key driver of the fund’s returns and Riverstone believes that it can make good returns in a falling oil price environment. Most of the fund’s capital has not yet been invested. Furthermore, the group appears well placed to exploit the environment, with considerable firepower to invest in distressed operations.”
The trust was launched in October 2013 over which time it has returned lost 8.13 per cent. However, that compares to a 23 per cent fall from the MSCI AC World Energy index.
Performance of trust versus index since launch
Source: FE Analytics
Lovett-Turner does point out that the trust’s fee structure could be an unattractive feature, however.
It has a management fee of 1.5 per cent of net assets plus a performance fee of 20 per cent of realised profits on an asset by asset basis, although Riverstone will reinvest its share of the performance allocation net of taxes into ordinary shares.
