With a number of investment trusts currently trading on discounts thanks to the recent market volatility, investors may believe that it isn’t worth even considering buying into anything trading on a premium.
Of course, highly-rated, top-performing trusts with experienced managers never tend to trade out on a wide discount to NAV. However, there is always the risk that investors can be hit hard by buying closed-ended funds on expensive ratings as if those wide premiums were to fall (as they often do), then they are likely to incur capital losses.
Therefore, in this article, FE Trustnet asks a panel of investment professionals and trust specialists about some of the most well-known names in the closed-ended world which are currently trading on premiums to NAV and whether investors should be looking to avoid, sell or even buy.
Lindsell Train Investment Trust
This five crown-rated trust has been trading on a significant premium for a number of years, and currently, this stands at a hefty 36.1 per cent. 
In the past, in fact, manager Nick Train (pictured) has warned investors against buying into the trust as it is too expensive, and Winterflood Securities’ Kieran Drake believes it is prudent to take this advice on board despite rating the management team highly.
“We are generally cautious on funds trading at significant premiums,” he said. “Some may argue that the premium reflects the price investors are willing to pay for the holding in the management company, although last year the fund moved to revaluing its holding in the management company on a monthly basis.”
The £112.5m trust has been managed by FE Alpha Manager Train since its launch in 2001, and over this time frame it has returned 484.04 per cent, more than tripling the performance of its peer average in the IT Global sector.
Performance of trust vs sector since launch
Source: FE Analytics
Not only is it in the top decile over one, three, five and 10 years, it was also top-quartile in seven out of the last 10 years on an annualised basis.
“It has a strong performance record and is differentiated from its peers by its holding in its management company,” Drake continued.
“It has historically traded on a significant premium to its NAV, but is currently at the upper end of this range.”
Almost one third of the trust is invested in Lindsell Train Ltd (which is unquoted), and its top 10 holdings account for an 84.3 per cent weighting in its portfolio. Other large holdings include Diageo, AG Barr, Unilever and Lindsell Train Japanese Equity.
Its premium is 15.82 per cent higher than its one-year average and is more than double its premium average over three years, although it has traded on a 37.47 per cent premium over the past 12 months.
The reason the trust is so highly-rated is due to the fact it is relatively small and has a very sticky investor base.
However, rather than paying almost a third more than the value of the trust’s assets, Drake would recommend opting for Finsbury Growth & Income, which is also managed by Train and focuses on UK investments. The trust is currently trading at a 0.1 per cent premium, yields 2.1 per cent and has an ongoing charge of 0.82 per cent.
Lindsell Train Investment Trust yields 1.3 per cent and has an ongoing charge of 1.18 per cent, and charges a performance fee.
While the trust is currently trading on an 8.2 per cent premium, Cantor’s Charles Tan warns investors that Law Debenture is a special case as part of its portfolio is not included in its NAV.
“With regard to Law Debenture, I think it’s worth reminding investors that the premium is optical and a by-product of some conservative accounting,” he explained.
“[The trust’s] independent fiduciary services (IFS) business is held on the balance sheet at book value, or about 2.5x last year’s earnings, and accounts for only around 3.5 per cent of the last published NAV.”
“If the IFS business was LSE-listed, it would almost certainly be worth more. Just to give you an idea of how much more, Sanne Group recently came to the market and currently trades at approximately 30x estimated 2015 earnings.”
“I’m not saying that Law Debenture’s privately-held IFS business should be valued on the same multiple as Sanne (or that it would ever be spun off as an independently listed entity), but even if we just assume that a 15x P/E multiple is a more appropriate valuation (the FTSE All Share trades at around 15x), then the trust should trade at a 17 to 18 per cent premium to its official NAV, making the current 8 per cent premium look relatively inexpensive.”
The £581m trust is managed by FE Alpha Manager James Henderson, and aims to achieve both capital growth and a steadily increasing income through investments across the globe.
It is in the top quartile for its performance over 10 years, having achieved a total return of 134.01 per cent compared to its peer average’s return of 82.59 per cent.
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
Its shorter term performance hasn’t been as strong though, with the trust switching in and out of third and fourth-quartile over one and three years as well as over the last three and six months.
“Law Debenture recently secured £75m of 30-year financing for a very attractive 3.77 per cent rate of interest, which I think will prove accretive to shareholder returns over time,” Tan said.
“While performance has been lacklustre recently due to some of the manager’s positions in resource-related stocks (which, with the benefit of hindsight, he may have been too early to accumulate), his rationale for owning them is economically sound and his long-term track record suggests that we should trust in his stock-picking abilities and ride out the volatility.”
Law Debenture currently yields 3.3 per cent and has an average annualised dividend growth over five years of 3.7 per cent.
It is 12 per cent geared and has an ongoing charge of 0.46 per cent.
Woodford Patient Capital Trust
Star manager Neil Woodford’s Patient Capital trust initially got off to a flying start after its launch last year, but more recently it has dropped below its peer average in the IT UK All Companies sector. It shares are now down 3.5 per cent since its first day of trading.
Performance of trust vs sector since launch
Source: FE Analytics
However, the reputation that he has built up during his time at Invesco Perpetual and the strong performance his open-ended fund has achieved since its launch has led investors to carry on buying into the trust nonetheless, leading to its current 3.2 per cent premium.
Ben Conway, fund manager at Hawksmoor, says that the team is always wary of buying investment trusts on a premium and would only ever do so if it thought there was a good reason for that premium to persist. For instance, this could be the case if the trust invests in assets that are both scarce and cheap in value.
“With investment trusts that have close substitutes (such as open-ended funds, which you can obviously purchase virtually at NAV), we would always be wary of paying a premium as it might not persist. Indeed, in an era of such low interest rates, investors should be more focused than ever on not over-paying for anything,” he said.
“Patient Capital’s premium of around 3 per cent is actually within a whisker of its historic low and practically at the offer price but we still have some alternative suggestions available.”
While the manager rates Woodford and his team very highly, he believes that there are more nuanced ways to play these themes such as his aim for long-term growth and his large weighting to the healthcare sector. In fact, Conway would recommend buying Woodford’s open-ended fund as an alternative.
“This would be our first port of call,” he said. “If you like Patient Capital’s exposure to unquoted or very small listed companies, then we would suggest looking at either specialist micro-cap equity funds (we like Downing UK Micro-cap Growth and Wood Street Microcap in the open-ended space) or specialist private equity investment trusts such as HG Capital (which trades at a historically wide 15 per cent discount) or Graphite Enterprise (at a 20.6 per cent discount).”
“Finally, if it is the exposure to a specific combination of healthcare and small companies then there are some very good healthcare-dedicated funds – we use Polar Capital’s Healthcare Opportunities fund (open-ended) and also rate their Biotechnology fund highly – both give access to the sector across the market cap spectrum.”
Woodford Patient Capital Trust is £796m in size and has an innovative fee structure with no base fee and a performance fee of 15 per cent of any excess returns over a 10 per cent cumulative hurdle rate per annum, subject to a high watermark.
