A vote to remain within the European Union (EU) in the looming ‘Brexit’ referendum could lead to a share price boost for investment trusts, according to analysts, after retail investors pulled back from the vehicles in recent months.
In the opening three months of 2016, almost all of the major investment trust sectors aside from infrastructure and healthcare were hit by a de-rating. UK smaller companies trusts have witnessed the biggest de-rating, followed by those focusing on technology and Europe.
Data from Winterflood Securities shows that the average sector discount among investment trusts widened to 7.9 per cent (excluding private equity, hedge funds and direct property) by the end of March. This is up from 7.8 per cent at the end of February and 4.8 per cent at the start of 2016.
What’s more, five equity sectors within the investment trust universe were trading on an average discount to net asset value (NAV) of more than 10 per cent at the end of March. Infrastructure and UK direct property are the only trust sectors to trade on a premium to NAV, on average.
Trust discounts/premiums by subsector (with debt at par)
Source: Winterflood Securities, Thomson Reuters Note: non‐equity asset classes shown in grey
Winterflood’s analysts argue that the fact UK growth and UK smaller companies trusts are included among the sectors with discounts higher than 10 per cent suggests the UK equity market is “increasingly out of favour with investors”. It argues that concerns over the impact from the Brexit vote on 23 June could be the driving force behind this.
“Discounts have widened out across the investment trust universe so far this year against a backdrop of volatile market conditions, concerns over slowing global economic growth and the uncertainty generated by ‘Brexit’. We believe that this has resulted in a temporary decline in retail investors’ demand for investment trusts. This can be best seen in sub‐sectors that are dominated by retail holders, such as UK equity income,” Winterflood said.
“Interestingly, discounts widened out for this sector in the first quarter of last year in the run‐up to the UK general election, when the likely outcome was not clear. Following the conclusive result the discount rebounded and we wonder whether a similar pattern may be seen after 23 June this year, depending on the outcome.”
“Should the UK vote to remain in the EU, a relief rally may ensue that could see discounts narrow. Conversely, if the result is to leave or even be so close as to leave the issue on the table, then the uncertainty may continue.”
The below graph shows how UK investment trusts struggled to make headway in total return terms over the opening months of 2015, only to see a strong rebound over the three months after a Conservative majority was returned on 8 May.
Performance of sectors between 1 Jan 2015 and 7 August 2015
Source: FE Analytics
Since the end of March, the discount in the Association of Investment Companies’ (AIC) UK All Companies sector has narrowed but still stands at 7.3 per cent. The trust on the highest discount is Artemis Alpha at 25 per cent, followed by Manchester & London at 23 per cent and Henderson Opportunities at 15.7 per cent.
Within this sector, Winterflood recommends two well-known trusts: Fidelity Special Values and Woodford Patient Capital.
Fidelity Special Values, headed by FE Alpha Manager Alex Wright, is trading on a 7.4 per cent discount to NAV. The £518m trust focuses on out-of-favour stocks where the manager sees the potential for positive change, currently focusing on banks and recently increasing weightings to oil & gas; it also tends to be overweight small and mid-caps, given Wright’s expertise in this area.
FE Alpha Manager Neil Woodford’s £773.2m Woodford Patient Capital trust, which is trading on a 4.5 per cent premium, invests the bulk of its portfolio in in early-stage and early-growth companies that are working on innovative products or services and have “outstanding intellectual property”. The manager has argued in the past that leaving the EU would not necessarily damage the UK economy, saying it is difficult to make a credible economic argument for staying in or leaving the union.
When it comes to UK equity income, the average discount in the sector is 4.2 per cent. Value and Income’s is the highest at 21.6 per cent, while Small Companies Dividend and Shires Income both have discounts of more than 12 per cent.
Here, Winterflood tips Edinburgh, Lowland and Temple Bar.
Temple Bar, which is managed value investor Alastair Mundy, has the highest discount at 8.7 per cent. The trust is currently bottom quartile over one, three and five years, partly owing to the underperformance of value against growth and momentum, although a number of commentators have tipped the style as being prime for a rebound.
Performance of trusts vs sector and index over 3yrs
Source: FE Analytics
FE Alpha Manager Mark Barnett’s £1.3bn Edinburgh investment trust, on the other hand, is first quartile over one, three and five years thanks to the manager’s preference for defensive blue-chips and a 23.1 per cent allocation to strong performers from the FTSE 250. It’s trading on a 3.5 per cent discount, according to the AIC.
Lowland, run by FE Alpha Manager James Henderson and trading on a 3.3 per cent discount, is another that looks to capitalise on opportunities in small and mid-caps, as it will normally have a maximum of its portfolio in FTSE 100 companies. Henderson also has a value/contrarian approach to investing.
The AIC’s UK Smaller Companies sector is trading on the highest average discount at 12.1 per cent. At 25.1 per cent, SVM UK Emerging has the highest discount although Gresham House Strategic is close behind at 25 per cent while Rights & Issues is on a 20.1 per cent discount.
Henderson Smaller Companies is recommended by Winterflood’s analysts. Neil Hermon’s £458.1m trust is trading on a 13.9 per cent discount; it has been as low as a 4.1 per cent discount in the past 12 months. Despite the double-digit discount, the trust has outperformed its average peer over the past one, three, five and 10 years.
