Given the volatility of the UK market and its rocky start to the New Year, investors would be forgiven for erring on the side of caution at the moment.
One way to do so would be to buy into investment trusts trading on discounts in order to minimise the potential loss of capital.
However, trusts are often trading on discounts for a reason and as such, it can be difficult to find one that is both attractively valued and likely to deliver a strong performance.
Two of the UK trusts trading on significant discounts at the moment, however, have both provided significant returns over the long term and are household names – one of which is FE Alpha Manager James Henderson’s Henderson Opportunities Trust (HOT), and the other is Alastair Mundy’s Temple Bar Investment Trust (TMPL).
Both trusts adopt very different investing techniques, with HOT residing in the IT UK All Companies sector and Temple Bar sitting in the IT UK Equity Income sector. 
While Henderson (pictured), whose trust is trading on a 12.8 per cent discount, particularly likes smaller technology and pharma companies for growth maximisation, Mundy, whose trust is on a 5.3 per cent discount, prefers to hold large dividend-paying blue-chips and particularly those in the financial sector thanks to his contrarian approach.
However, if an investor was looking to buy into a UK trust trading at an attractive valuation, which of these would be their best bet?
“Temple Bar focuses on contrarian value investing – i.e. undervalued, out-of-favour companies with strong balance sheets,” Cantor Fitzgerald’s Charles Tan said.
“Examples of holdings that are or have been in the portfolio historically are household names such as BP, Morrisons and RBS, which the manager reasons have fallen on hard times, but are still solid businesses at their core and should rebound from oversold levels with the proper restructuring and time.”
One of the positives that the director of investment companies research notes is that Mundy’s strategy naturally produces a healthy income, and currently it boasts a 4 per cent dividend yield.
Its performance is also strong over the long term, having provided a total return of 272.64 per cent over Mundy’s 14-year tenure and outperforming its peer average and benchmark by 32.91 and 88.51 percentage points respectively.
Performance of trust vs sector and benchmark over manager tenure
Source: FE Analytics
While it also sits comfortably in the second quartile over 10 years, the trust has fallen to the bottom quartile over one, three and five years as well as over the last three and six months.
Mundy attributes this to what he has previously described as “value hell”, as a result of too many headwinds and too few attractively-valued opportunities in the market at the moment.
“Mundy himself is disappointed with performance as TMPL has done well in absolute terms and outpaced the FTSE All Share benchmark, but has lagged its peers over three and five years as the liquidity-driven market post financial crisis has tended to favour ‘growth’ rather than ‘value’ investing,” Tan explained.
Because of the manager’s bearish outlook and his belief that we are still in the throes of a financial crisis, the trust currently has a 12.1 per cent weighting in cash. Aside from this, it currently holds 25.3 per cent in financials, 14.8 per cent in industrials and 13.4 per cent in oil & gas, alongside smaller weightings in the likes of services, healthcare and consumer products.
The trust has an average dividend growth per annum of 2.6 per cent over five years, is 4 per cent geared and has an ongoing charge of 0.48 per cent.
In contrast, Henderson’s growth-focused HOT has a much higher gearing at 21 per cent and has an ongoing charge including a performance fee of 1.23 per cent.
While its charges are greater though, its current discount is more than twice that of TMPL’s.
“Performance [of the trust] can be volatile in the short term owing to gearing and the bias toward UK small caps, but Henderson is still one of the most dependable managers in the sector over the longer term,” Tan said.
“Some of the largest positions in the portfolio today are in smaller biotech and technology-related stocks which boast enviable earnings and sales growth but often no dividends as they reinvest for further growth.”
The five crown-rated trust is just £90m in size compared to TMPL’s AUM of £833m, and 29.84 per cent of this is in the industrials sector. It also has a 22.6 per cent weighting in the services sector, 19.07 per cent in healthcare and 17.92 per cent in financials.
Since the trust’s launch in 2007, it has marginally underperformed its sector average and benchmark. However, it has more than doubled the performance of its peer group composite and more than tripled the FTSE All Share over five years, landing it a place in the top quartile over this time frame.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
“Performance has been very good over three and five years, with outperformance driven not just by favourable market conditions but positive stock picking as well, however, recent risk-off sentiment has dented demand for smaller companies detracting from one-year returns,” Tan explained.
Largely because of the star manager’s penchant for smaller stocks, the trust is in the bottom decile for its maximum drawdown, which measures the most money an investor would have lost if they’d bought and sold at the worst possible times, and for its annualised volatility, over one, three, five and seven years.
While Temple Bar has found itself in the bottom decile for its maximum drawdown over one and three years, it has dipped in and out of the second quartile for this and for its annualised volatility over the longer term.
With so many different metrics, not to mention completely different investment styles, to consider, which of the aforementioned trusts would be a better purchase at the moment?
“It’s hard to say which one is better, or which one investors should buy at this point in the cycle, because it’s like asking me which side of my hand I like better,” Tan said.
“I would argue that both funds are sufficiently differentiated from each other that they both deserve a place in any investor’s portfolio, within the UK allocation. TMPL should perform well in an environment where investors shift their attention back towards valuations instead of blindly focusing on growth, and it feels like we might be at the beginning of such a shift with the highly valued US market correcting, and pricey tech names (e.g. Amazon) bearing the brunt of the selling.”
“While HOT might face headwinds in such an environment, as I’ve said before, I wouldn’t want to bet against James Henderson on a five-year view, because I believe that the contributions from positive stock picking would outweigh any market weakness (save for a replay of the 2008 financial crisis, in which case, all bets are off and both trusts, being equity long-only strategies, would find it hard to post positive absolute returns).”
